Stock buybacks are going out of vogue

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      By Edward J. Perkin, CFA, Chief Equity Investment Officer, Eaton Vance Management

      Boston - Last year was a record for announced stock buybacks in the U.S., eclipsing the $1 trillion level for the first time. I expect this will ultimately turn out to have been a peak year. Public companies will continue to buy back their own stock in 2019, but they will do less than last year. There are several reasons for this.

      First, 2018 was an elevated year due to the passage of the tax bill. This had the effect of lowering statutory corporate tax rates (raising earnings and cash flow levels) and "deeming" overseas cash balances to have been repatriated at a low tax rate (removing the incentive to hold cash overseas). Some of this cash was used for buybacks.

      Second, political pressure against buybacks has begun to mount. Surprisingly, this is coming from both sides of the aisle. Democratic senators Chuck Schumer and Bernie Sanders co-authored an op-ed in the New York Times in early February in which they wrote:

      "[C]orporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers and the long-term strength of their companies, helping to create the worst level of income inequality in decades. One way in which this pervasive corporate ethos manifests itself is the explosion of stock buybacks."

      On the Republican side of the aisle, Senator Marco Rubio unveiled a plan to change the tax rules on buybacks so that shareholders would be deemed to have received an imputed "dividend," on their pro rata share of the buyback, which would be subject to taxation.

      I believe there is a compelling counterargument to the political complaints -- the cash used for buybacks does not disappear from the economy, but finds its way to more-productive uses -- but the political pressure is real, nonetheless.

      Another source of pressure is beginning to come from an unlikely source -- shareholders. In the most recent BofA Merrill Lynch Fund Manager Survey, global investors have begun to express a strong preference for balance sheet deleveraging over other uses of cash.

      I am highly opinionated on the topic of buybacks and capital allocation decisions generally. There are only five things that a company can do with its excess cash if decides to spend it: (1) reinvest in the business through capital expenditures, (2) make an acquisition, (3) pay a dividend, (4) pay down debt, or (5) buy back stock. At any given moment, for any given company, the correct pecking order of these five options will be different. The guiding principle, as articulated by the great capital allocator Warren Buffett, should be to do the thing that maximizes the intrinsic value per share of the company. Intrinsic value is an important concept, but one that is difficult to precisely calculate. A simple definition might be the net present value of all future cash flows into perpetuity, discounted at an appropriate interest rate. This is distinct from the stock price, which may drift away from intrinsic value. Focus on maximizing the per-share intrinsic value of the company and the stock price will eventually follow suit.

      Bottom line: I believe the vast majority of C-suite executives put limited thought into all-important capital allocation decisions, and have a flawed process that destroys shareholder value. This leads to mal-investment across the economy, lower GDP per capita growth, lower productivity improvements, stagnant wage growth, and slower improvements in the standards of living for ordinary people, which should be the great promise of free market capitalism.