Share buybacks have long been controversial.
The tactic of inflating earnings per share by repurchasing shares from the market and retiring them gives companies a way of growing earnings per share without actually increasing underlying profits. Wall Street generally cheers the maneuver, as it sees it as one way of returning to cash to shareholders (the other being dividends). Companies often prefer to return capital with share buybacks instead of dividends, as investors expect dividends to be consistent and generally to grow each year, while buybacks can be deployed strategically when the stock price is low and management thinks it's cheap.
Select politicians and activists, on the other hand, have long decried buybacks as a financial engineering gimmick and a tool for corporate bigwigs to enrich themselves and shareholders rather than invest to grow their business and hire more people. In the aftermath of the 2017 tax cut, stock buybacks surged as corporations used the tax windfall to repurchase their own shares and juice per-share profits. This move provoked loud jeers from critics.
Today, we're nearly one month into an epic market crash. The Dow Jones Industrial Average has given up all of its gains since President Trump's inauguration in January 2017, erasing a three-year surge in a little more than three weeks. A bear market would seem to be just the kind of opportunity for companies with the available cash to capitalize on repurchases.
To buy back or not to buy back?
With the S&P 500 now down about 29% since its peak on Feb. 19, some companies spy an opportunity to buy back stock at a discount. Most companies are choosing to suspend share buybacks amid the current uncertainty, including Gap (NYSE:GPS), Denny's, and Expedia, while Zara-parent Inditex, the world's biggest apparel retailer, just suspended its dividend. That trend shows that companies generally see an economic shock approaching them, especially in the consumer discretionary sector, as industries like retail, restaurants, and travel are seeing demand quickly dry up.
Oracle, the legacy tech giant, recently increased its share repurchase authorization by $15 billion. CEO Safra Catz defended the move on the recent earnings call and said the company could easily support its dividend, which yields 2%, adding on its earnings call last week, "We have been buying back our stock. We think it's an incredible deal. It's basically gone on clearance sale in the past few days and we think it's an enormous, it's a fantastic investment and it reduces the number of outstanding shares or otherwise known as partners we have to share our very good profits with."
Oracle's stock has outperformed the market during the sell-off, down 14% compared to a loss of 28% in the S&P 500.
Last week, Monster Beverage authorized a $500 million share repurchase on top of its existing allowance of $536.6 million. Though the company did not make a statement about the decision, it likely signals that management is aiming to accelerate its repurchases. Monster shares have fallen 19% since the recent sell-off. As an energy-drink maker the company will likely see a sales decline during the pandemic, but this is a highly profitable company with a rock-solid balance sheet. If Monster's stock continues to fall, management will likely take advantage of the opportunity to buy it back at a discount.
Nomad Foods, the parent of frozen-food brands like Bird's Eye, has also tossed its hat into the share-buyback ring, authorizing a $300 million repurchase program, equivalent to about 10% of its market cap. Like Monster, Nomad didn't explain the move, but the company is a defensive, consumer staples stock and should hold up well over the current volatile period. During the recent pullback, the stock is down 22%.
Is it a buy signal?
Companies don't always know when the best time to buy back their stock is, and are generally poor judges of when it's a good deal. However, Oracle, Monster, and Nomad look more stable than the broad market, as their businesses shouldn't be as directly impacted as those in other sectors like consumer discretionary and cyclicals, which are likely to be hit by the pandemic and the recession that could follow. Though the market could certainly fall further from here, I'd expect these well-capitalized stocks to continue to outperform.
On the other hand, companies like Gap that are suspending their dividends despite trading at rock-bottom valuations based on trailing earnings could be in trouble. Stocks that are suspending buybacks despite their low prices are sending a clear signal that they see a great degree of uncertainty ahead. Given the unique situation we're in, with a pandemic threatening the global economy, these stocks are probably best avoided for now.