In this segment of the Market Foolery podcast, host Chris Hill and Foolish investor-at-large Tim Hanson dig into one possible result of the Republican tax overhaul passed in December, which gave major tax breaks to businesses.
It's beginning to look like many companies may be delivering that wealth back to their shareholders in the form of buybacks, which boost the value of the remaining shares outstanding. And while that may not be as impressive to some investors as pouring the funds directly into growth and innovation, there are reasons to think it's not such a bad idea for the businesses.
A full transcript follows the video.
This video was recorded on Jan. 31, 2018.
Chris Hill: So, as I mentioned, we're just starting to heat up in terms of earnings season. I said that the other day, and I'm curious what your thoughts on this are. It has to do with buybacks. You mentioned the tax plan, and what we saw with Electronic Arts. By the way, we saw this last week with Johnson & Johnson, where the headline on Johnson & Johnson's latest quarter was, they posted a loss of nearly $11 billion. And it's just like, what happened?! And it's like, well, no, it's because of the taxes. Do you think we're going to see a lot more companies, or even just an above average number of companies, this earnings season and possibly even next earnings season, announcing increased buyback plans? We saw that with Lowe's come out the other day and really ramp up their share buyback plan. And for companies that have, all of a sudden, with the new tax law, they have more capital, that seems like the easiest lever to pull.
Tim Hanson: Yeah, the buyback situation is interesting. Obviously, buybacks have been very popular for a number of years now. Some people think these are the largest amounts of buybacks being made in history, though there are a lot of ways to adjust for that. Obviously, I think buybacks are a popular use of capital, but I don't think it's necessarily for the reason why a lot of people think. There's a good research paper that came out at the end of last year called "The Premature Demonization of Stock Repurchases." It's AQR Capital Management, Cliff Asness' shop, put it out. And basically, a lot of people think that repurchases are either one, that means companies are foregoing investment in growth, or two, they're just trying to prop up their stocks or artificially boost earnings per share. I think what the paper shows is, none of that is really true, and maybe the only argument you can make is, in this very low-interest rate environment, debt financing is cheaper than equity financing, so why would you not take out debt to buy back your stock? You're simply swapping out one more expensive source of financing for another. As long as interest rates remain where they are, there's no reason why that shouldn't continue. It means that, at the end of the day, your financing source is a lot cheaper, so, the company is probably going to end up keeping more of its gains for itself down the line.
Chris Hill owns shares of Johnson & Johnson. Tim Hanson has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool recommends Electronic Arts and Lowe's. The Motley Fool has a disclosure policy.