Howard Schultz settled back into his familiar role as Starbucks (SBUX -0.35%) CEO on April 4 and immediately captured headlines with his decision to suspend Starbucks' share buyback program. Starbucks had announced last fall that it planned to spend $20 billion on stock buybacks and dividends between fiscal 2022 and fiscal 2024. For context, Starbucks spent $5.8 billion on dividends between fiscal 2019 and fiscal 2021.
Let's look at the pros and cons of stock buybacks to see if Starbucks is making a mistake by suspending the buyback program or if it could end up being a net positive for long-term investors.
Image source: Getty Images.
Have stock buybacks worked?
The U.S. Securities and Exchange Commission (SEC) made stock buybacks legal in 1982. Since then, corporate buybacks have surged to become a major way that companies deploy capital.
Buybacks can be a sign that a company believes its stock is undervalued. If this is the case, then buying back a company's own stock could be a better use of capital than reinvesting in its business. Yet there are data to suggest that buybacks have generally been unsuccessful, especially recently.
Launched on Nov. 29, 2012, The S&P 500 Buyback Index tracks the performance of the 100 stocks with the highest buyback ratios in the S&P 500. Over the last seven years, five years, three years, and one year, this index has produced a lower total return than the S&P 500 -- signaling that buybacks may not be the best use of capital.
|
Total Return |
1 Year |
3 Years |
5 Years |
7 Years |
|---|---|---|---|---|
|
S&P 500 |
14.68% |
66.47% |
111% |
151.3% |
|
S&P 500 Buyback Index |
10.28% |
57.08% |
96.9% |
119.9% |
Data source: YCharts.
When stock buybacks make sense
Stock buybacks can make sense for stable companies with limited growth potential. A good example of a company that routinely buys back its own stock and probably should continue to do so would be Procter & Gamble (PG 0.60%). P&G plans to pay over $8 billion in dividends and repurchase between $9 billion and $10 billion of its own stock in fiscal 2022. P&G tends to have a low-to-mid single-digit organic growth rate. Incremental improvements and earnings are the name of the game as most investors hold P&G for its growing dividend, consistent earnings growth, and ability to perform well even during recessions.
Another great example of when stock buybacks make sense is for companies that don't pay dividends (or only small ones) and have an abundance of cash. Both Apple and Berkshire Hathaway have massive cash positions and are known for buying back their own stock when it makes sense to do so because there is an opportunity cost associated with sitting on too much cash.
When stock buybacks don't make sense
Stock buybacks don't make sense for young companies that need capital to grow or for a company with an overvalued stock price. More generally, stock buybacks don't make sense for any company that can make better use of its capital.
Stock buybacks can lead to short-term boosts in a company's stock price. Or in the case of Starbucks, pulling the rug out from under future buybacks can lead to short-term sell-offs. Since executive compensation is heavily dependent on stock options, and therefore the company's stock price, buybacks can be a way to boost performance even if it comes at the detriment of the company's long-term success.
The glass half-full outlook
Investors who believe in Starbucks' growth potential should cheer Schultz's decision to suspend the buyback program for the simple reason that Starbucks is better off using that money to grow its business, lower its environmental footprint, and improve its company culture. Starbucks' short- to medium-term performance would have probably benefited from the buybacks. But you could argue that the company will stand to benefit more from investing in the actual business.
We don't yet know exactly how Starbucks plans to reallocate capital. But we do know that the company had made environmental, social, and governance (ESG) commitments toward lowering its carbon footprint and raising employee wages over time. Starbucks has successfully grown its rewards program and mobile ordering and continues to invest in stores with drive-throughs. Focusing on grab-and-go sales via in-store pickup or the drive-through could prove to be the next growth catalyst for Starbucks.
Thinking big picture
At first glance, a stock buyback looks like a good move if the performance of the company's stock exceeds the gain the company could have made on other investments. For example, if Starbucks buys back its own stock at $90 a share and the stock doubles to $180 per share in five years, then the company would have had to make an investment that doubled in five years in order to justify not buying back its own stock.
However, this argument is grounded in performance over a limited time frame. Rather, the better and longer-term point is that a company like Starbucks should be using capital to make its business better, larger, and stronger -- whether that's through building more stores, improving existing stores, creating a better company culture for its employees, lowering its environmental footprint, etc. Stock buybacks do none of that; all they do is lower the number of outstanding shares. In fact, stock buybacks don't really help the real economy, while capital expenditures used to create jobs and advance progress do.
With a dividend yield of 2.3%, Starbucks remains an excellent dividend stock and could create even more long-term value for shareholders if it is able to successfully lean into grab-and-go ordering, execute ESG initiatives, and revitalize its company culture.
