Friday’s article blog pointed out that in 2018, only 43% of companies in the S&P 500 Index incurred any expenses for research and development.
And just 38, or 7.6%, of companies accounted for 75% of the R&D spending of all 500 companies in the index.
So, I asked, where’s all the corporate cash been going?
By Dave Allen for Discount Gold & Silver
Friday’s article blog pointed out that in 2018, only 43% of companies in the S&P 500 Index incurred any expenses for research and development.
And just 38, or 7.6%, of companies accounted for 75% of the R&D spending of all 500 companies in the index.
So, I asked, where’s all the corporate cash been going?
Over the ten years ending in 2018, S&P 500 companies spent a collective $4.3 trillion on stock buybacks — 52% of their net income during that period.
On top of that, the companies spent another $3.3 trillion on shareholder dividends — 39% of net income.
Those two figures imply that no more than 19% of corporate net income went to R&D over that period. Unimpressive indeed.
Fast forward another three years, and Wall Street banks are on the verge of unleashing a flood of new buybacks and dividend increases.
It’s coming after they passed the Federal Reserve’s latest stress tests with a huge wad of cash they built up during the pandemic.
The early estimates suggest that the six biggest U.S. banks — JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley — could return more than $140 billion in silly money to shareholders…to start.
A beautiful thing, if you’re a bank or other corporate executive whose compensation package is based more and more on stock bonuses.
Bad, however, for other — lower paid — company workers and the economy in general.
Why Such a Big Deal?
Concern has been growing in recent years over skyrocketing corporate debt that could take an already fragile economy into a deeper downturn than the one we’re just coming out of that could quickly spin out of control.
The cause of such concern is the trillions of dollars that U.S. corporations have spent on stock buybacks — also known as open-market repurchases — since the Great Recession (see 2009-2018 stats above).
In 2018 alone, thanks to corporate profits boosted by the Tax Cuts and Jobs Act of 2017, companies in the S&P 500 Index engineered $806 billion in buybacks — about $200 billion more than the previous record set in 2007.
Here’s the thing: When companies do these obscene levels of buybacks, they deprive themselves of the liquidity that could help them cope when sales and profits fall during an economic downturn.
More importantly, they use a significant funding pool that otherwise would be available for research and development — and more generous employee compensation and other productivity improvements.
If that’s not bad enough, the portion of buybacks funded by corporate debt reached as high as 30% in 2016 and 2017.
So, now the Big Boys are issuing bonds to buy back their own shares of stock.
In a study published by Harvard Business Review early last year, before the pandemic, co-authors William Lazonick, Mustafa Erdem Sakinc and Matt Hopkins observed:
“Taking on debt to finance buybacks is bad management, given that no revenue-generating investments are made that can allow the company to pay off the debt.
“[I]nvestments in the company’s knowledge base (its employees) fuel innovations in products and processes that enable it to gain and sustain an advantage over other firms in its industry.
“The investment in the knowledge base that makes a company competitive goes far beyond R&D expenditures.”
Motives Are Not Necessarily Pure
So, why then do companies continue these massive buybacks? One of the answers, unfortunately, is obvious:
With the majority of their compensation coming from stock options and stock awards, senior corporate executives have used buybacks to manipulate their companies’ stock prices to their own benefit.
(Others who are in the business of timing the buying and selling of publicly listed shares also benefit handsomely).
Buybacks, simply put, enrich these opportunistic share sellers — e.g., investment bankers, hedge-fund managers and C-level executives — at the expense of other employees as well as continuing shareholders.
Buybacks make the issuing company look artificially better than they are by reducing the assets on a company’s balance sheet, in this case, cash. As a result, return on assets (ROA) increases because assets are reduced.
Return on equity (ROE) also increases, because there’s less outstanding equity.Generally speaking, investors and market analysts view higher ROA and ROE as good things.
Here’s how a theoretical buyback works: Say a company buys back 1 million shares at $15 per share for a total cash outlay of $15 million.
Below are the components of the ROA and earnings per share (EPS) calculations and how they change as a result of the buyback.
Before Buyback After Buyback
Cash $20,000,000 $5,000,000
Assets $50,000,000 $35,000,000
Earnings $2,000,000 $2,000,000
Shares
Outstanding 10,000,000 9,000,000
ROA 4.00% 5.71%
EPS $0.20 $0.22
As shown above, the company's cash has been reduced from $20 million to $5 million. Because cash is an asset, this will lower the total assets of the company from $50 million to $35 million.
That increases ROA, even though earnings have not changed. Before the buyback, the company's ROA was 4.0% ($2 million ÷ $50 million). After the repurchase, ROA increases to 5.7% ($2 million ÷ $35 million).
A similar effect can be seen for EPS, which increases from 20 cents ($2 million ÷ 10,000,000 shares) to 22 cents ($2 million ÷ 9,000,000 shares).
A Word About Dividends. As a quick aside, dividends, as opposed to buybacks, provide a yield to allshareholders for holding shares.
But excess dividend payouts can undermine investment in productive resources the same way that buybacks can.
If a company instead plows profits back into productive investments, its shareholders should still be able to earn capital gains if and when they decide to sell their shares. Back to buybacks…
Another criticism of them is that by artificially inflating the stock price of the companies that repurchase their own shares, they manipulate (i.e., artificially inflate) the level of the major stock indexes those companies are listed on.
In other words (and some use this as an argument in favor of buybacks), the stock market would be trading at a much lower level without them.
In fact, data compiled by Ned Davis Research in 2019 showed that the S&P 500 would be at least 19% lower without buybacks.
The firm looked at the S&P 500′s performance between the 1st quarter of 2011 and the 1st quarter of 2019 then subtracted the amount of net monthly repurchases to arrive at that conclusion.
To be fair, not everyone agrees that buybacks inflate a company’s earnings and are bad for the economy.
Author James Kostorhyz wrote in 2015:
“The argument that S&P 500 index earnings are inflated by share buybacks is simply false as a factual matter.
“By the same token, the related argument that the "true" PE of the S&P 500 is currently understated due to the impact of buybacks on S&P 500 EPS and/or that the "real" PE is actually higher than is reported, is also factually false (emphasis his).
“The S&P 500 index methodology adjusts the index for the impacts of share buybacks and other corporate actions; S&P adjustments effectively neutralize the effect of all such corporate actions on the index.”
I hear what Kostorhyz and his ilk are saying; I just fundamentally disagree with them. As they say, the devil’s in the details.
JPMorgan Chase Leads the Way (not a good thing)
A few of those details can be found in the annual 10-K reports filed by too big to fail JPMorgan Chase for 2017-2019.
Those reports show that the bank bought back a total of $59.5 billion of its own common stock over those three years, thus inflating its share price by that same amount.
Pam and Russ Martens ask in this week’s Wall Street on Parade, “Who benefitted tremendously from this boosting of the share price?” Their answer: “Insiders.”
According to JPMChase’s April proxy filed with the SEC, its Chair and CEO Jamie Dimon owns 9.4 million shares of the bank’s common stock — most of which he received via “performance” awards from his enabling Board of Directors.
Forget that Dimon’s “performance” has included overseeing a company that's racked up five felony counts and paid out more than $43 billion in fines and settlements for outrageous financial abuses since 2014.
The Martens report that, as of Friday’s closing, Dimon’s shares had a market value of $1.44 billion, illustrating how handsomely crime pays on Wall Street.
Dimon and very few others have benefitted to such an extent from buybacks, while thousands of the bank’s rank and file workers can’t even meet their monthly bills for the basic necessities of life. It’s good to be king.
Friday’s blog started with this warning: Stock buybacks and dividend payments are on the verge of gushing out of Wall Street banks’ faucets and breaking through the proverbial dam.
So, let’s end this story with this alternative caveat: Watch out below — stock buybacks and dividend payments…are about to break the bank!