How Share Buybacks Affect Your Investments

S&P 500 companies spent more on share buybacks in the second quarter: during the period, total outlays on share repurchases among the group rose 18.1%, to $118.1 billion from $100.0 billion in Q1. Compared to a year ago, buybacks are up 5.6% from $111.7 billion.

Apple Blurs the Picture

“The second quarter breaks into two stories—one with and the other without Apple,” said Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices, in a September 17 press release. “Apple spent $16 billion on buybacks in the second quarter, accounting for 13.5% of all buybacks in the period and setting a new index record for quarterly buybacks by surpassing International Businesses Machines’ Q2 2007 expenditure of $15.7 billion.”

“Excluding Apple, the 18.1% Q2 increase in buybacks becomes 2.0%,” continued Silverblatt. “If we adjust for the average stock price in Q2 being 6.3% higher than in Q1, the takeaway is that less shares were actually repurchased in Q2 than Q1, even as the headline, legitimately, reads 18%.” 

Look for Apple (NasdaqGS: AAPL) to claim an even bigger slice of buyback activity in the coming months, if activist investor Carl Icahn has his way. In August, Icahn tweeted that he’d taken a large position in the company (estimated to be around $1 billion) and is currently pushing the Cupertino tech giant to do a $150-billion buyback.

Icahn wants Apple CEO Tim Cook to take advantage of low interest rates to finance the move, which would come in addition to Apple’s pledge to return $100 billion of cash to shareholders by the end of 2015. As part of that plan, the company recently increased its repurchase authorization to $60 billion.

The Ins and Outs of Share Buybacks

Before we go any further, let’s take a step back and look at how buybacks work.

Companies have two main ways of returning cash to shareholders: buybacks and dividends. The latter are pretty straightforward: the company pays a certain amount for each stock held, usually on a quarterly basis.

Under a share buyback, a company purchases a certain number of its own shares. It may do this on the open market or by giving its shareholders the option to tender their stock to the firm, usually at a slight premium to the market price. It then cancels the purchased shares, reducing the total number outstanding and giving each shareholder a larger slice of the company.

Buybacks also increase earnings per share (because total earnings are divided by fewer shares) and tend to increase the value of the remaining shares.

In addition to Apple, here are two other companies that have spent heavily on buybacks this year:

  • Home Depot (NYSE: HD) has spent $4.3 billion on buybacks through the first half of its 2013 fiscal year (or as of August 4, 2013). It plans to repurchase an additional $2.2 billion worth of stock in the second half.
  • PepsiCo (NYSE: PEP) announced a new repurchase program in February that will allow it to buy back up to $10 billion of its common stock from July 1, 2013, through June 30, 2016. The new plan replaces its former authorization, which expired June 30.

In its third quarter earnings release, PepsiCo said it’s on track to return a total of $6.4 billion to shareholders in 2013. Of that total, $3.4 billion will come in the form of dividends and $3.0 billion will be share buybacks.

3 Things to Consider When Judging a Company’s Buyback Plans

  • Share buybacks allow you to defer taxes because you aren’t taxed on your gains until you sell your shares, while dividends are taxed in the year in which you receive them.
  • Buybacks may not materialize as stated: Many investors view dividends as a commitment, and any cut is likely to prompt them to hit the sell button. Slowing or stopping buybacks, however, isn’t liable to affect most investors’ view of the stock. Apple, for example, is under no obligation to stick to its pledge to buy back $60 billion of its shares by the end of 2015. Many firms never use all the funds their boards authorize for repurchases.

    This flexibility can be a plus if a company holds off on buybacks to pursue a new growth opportunity, for example, or make a profitable acquisition.
  • Timing is everything: Buyback critics often point to the fact that company managers often make repurchases when the stock is overpriced. An example occurred in the third quarter of 2007, when S&P 500 companies spent a record $172 billion on buybacks with the market near an all-time high.

    Spending on repurchases then plunged over 85%, to $24 billion, by the second quarter of 2009. During that period, the S&P 500 Index fell 47%. The end result? S&P companies had repurchased more shares when they were expensive and fewer when they were cheap.