Federal Reserve Chairman Jerome Powell sidestepped a verbal hand grenade in his Congressional testimony on Tuesday.
Sen. John Kennedy, R-LA, asked Powell where he stood on recent trial balloons to restrict the ability of corporations to buy back stock. Powell reflected for a moment and said that the allocation of capital has always been left to the private sector and “I would want to understand the consequences of changing that.”
It was a perfect answer to a politically divisive question. After buying back more than $900 billion in 2018, a record, corporations have shown no signs of slowing down in 2019, which has already seen $190 billion in announced buybacks, according to The New York Times.
Home Depot, in addition to providing disappointing 2019 guidance, announced Tuesday a massive $15 billion stock buyback, which if fully implemented and not diluted with additional stock options would reduce the shares outstanding by about 7 percent.
Even by recent standards, the Home Depot buyback is a large one, but it is part of a pattern that goes back many years. Home Depot has reduced its shares outstanding by more than a third in less than ten years:
- Shares outstanding in 2010: 1.7 billion
- Shares outstanding today 1.1 billion
- Share count reduction: 35 percent
Home Depot is in a class of corporations I call “buyback monsters,” companies that have reduced their share count outstanding by at least 25 percent since 2010. It is by no means alone. Nearly 80 companies in the S&P 500 have reduced their share count by at least 25 percent since 2010, and more than 100 (20 percent) have reduced their share count by 20 percent or more, including some of the most well-known companies in America:
Share count reduction since 2010:
- Travelers: 51 percent
- Autozone: 48 percent
- Kohl’s: 46 percent
- Northrup Grumman: 45 percent
- Lowe’s: 44 percent
- Gap: 42 percent
- IBM: 32 percent
- Apple: 26 percent
Source: S&P Global
What does it all mean and why are so many upset about all these buybacks? The implications are fairly clear: All other metrics being equal, Home Depot’s 35 percent share count reduction means that earnings appear 35 percent better, without any change in “fundamentals” like revenues, costs, or taxes.
No wonder corporations are so enamored with them.
This hasn’t stopped several Senators from making proposals to curb buybacks. Sens. Chuck Schumer, D-NY, and Bernie Sanders, I-VT, have proposed that companies should meet minimum requirements before being allowed to buy back stock, including a minimum pay level and benefits. Meanwhile Sen. Marco Rubio, R-FL, wants to reduce the tax advantages of buybacks by raising the rate paid by investors who sell their shares back to the company.
This kind of financial “engineering” has been criticized for years, but there seems to be precious little evidence that reducing the payout ratio — the percent of profits that are returned to investors through dividends and, by extension, through buybacks — would somehow magically improve profits, nor does there seem to be much evidence that corporations would automatically start spending more money on capital investments as an alternative. It’s even doubtful that this would be the best long-term strategy: throwing money into capital investments may not be an effective return on investment either. Corporations are perfectly capable of making boneheaded investments.
Do buybacks contribute to income inequality? To the extent that reducing shares outstanding improves the earnings picture, you can certainly argue that.
It’s also true that U.S. CEOs make far more money than their counterparts elsewhere, partly due to stock options and whether they are worth that extra pay is a discussion worth having.
But that’s not the root of the problem: The root of the problem is that the stock market has become a rich man’s game. A famous 2013 study by New York University economist Edward Wolff determined that the top 10 percent of the nation’s household by net worth own 84 percent of the stock market; the top 20 percent own 94 percent.
That means the bottom 80 percent own a measly six percent of the stock market.
Far better would be proposals to expand ownership of the stock market by making it easier to save for retirement. Expect more sensible proposals like this from The Wall Street Journal’s Jason Zweig on improving 401(k) investing.
This is the hornet’s nest that Powell stepped into. The Fed — and indeed the Congress — should indeed “understand the consequences of changing that” before stepping in and dictating to corporate America how it should spend its profits.