When looking to confirm news of a stock buyback plan, a first scroll through recent news releases of Medtronic PLC turned up nothing. There was just an item about a routine quarterly dividend.
And that was the right announcement, with the second paragraph explaining that the board had approved buying back $6 billion more worth of stock.
That bit of news seems more important than how it was played, but apparently buying back stock is so business-as-usual that it’s only really news if companies stop doing it. That might be one reason why the practice has become such a political issue.
Sens. Chuck Schumer and Bernie Sanders — clearly frustrated by lackluster wage growth for average workers and fat pay packages for corporate leaders — last month proposed limits on this kind of stock buyback in an essay in the New York Times. Buybacks shouldn’t be allowed, they wrote, unless companies first use their money to provide adequate wages, paid sick leave for employees and other measures that benefit workers.
Corporate leaders who might agree on those employment practices likely still will not want Congress making new rules, so if they want to head off something like this, they could start by being a little smarter about the practice of buying back stock and how they talk about it.
It’s often the case that share buybacks are one answer to the question of what to do with excess capital. After all, if corporate executives really don’t know how to productively invest all their employers’ money, the last thing we should want is for them to hang onto it.
The Medtronic news caught my eye because it is one of the latest big stock buyback announcements. The only regional blue-chip that easily comes to mind that might not be buying back stock right now is General Mills, which is instead paying back money it borrowed to buy pet food maker Blue Buffalo.
The other household names have buyback plans in place — Best Buy Co., Target Corp., U.S. Bancorp and so on. UnitedHealth Group has a share repurchase authorization that goes all the way back to 1997, according to its latest annual securities filing. As of the end of the year, UnitedHealth’s management had the authority from the board to buy back up to 94 million additional shares.
To their credit, none of these companies seems to be trying to use buyback announcements as some sort of signal of confidence to the capital markets.
This kind of thing can sometimes be baffling, including how the Wall Street Journal characterized Lowe’s Cos. $10 billion buyback news in December. The home improvement products retailer, it said, ”looks to turn investor sentiment and prove to Wall Street its business and growth plans are on solid footing.”
Wouldn’t the footing appear even more solid if $10 billion of additional cash and shareholders’ equity didn’t get drained away?
It’s also true that buying back stock reduces the number of shares outstanding, which can lead to earnings per share growing faster than net income. The pay practices for CEOs long ago crossed into indefensible territory for me, but it’s really aggravating if CEOs get paid for earnings-per-share growth that was only achieved by whittling away at the share count.
Lots of companies also seem far too eager to please the shareholders with buybacks. The way Target put it in its last earnings release is typical. The company said it “returned $951 million to shareholders in the fourth quarter through dividends and share repurchases, bringing the total to $3.4 billion for full year 2018.”
By linking stock buybacks directly with dividends, a form of distributing a slice of the profits, there’s no other conclusion other than the shareholders are getting a big payday.
That might not be the case, though. The Target shareholder who sold out last year, unaware that the buyer was Target, may be a bad-luck trader who bought the stock a few years ago at $82 a share and was willing to sell it to anybody at a loss.
What corporate executives should be explaining when announcing a corporate buyback is that it’s their job to allocate capital to only the best ideas. New warehouses, new stores, new lines of business and acquisitions of other businesses could all be savvy investments, but only if the expected returns beat the cost of the capital.
Profitable companies can generate more cash than they can wisely use. Through the first nine months of its current fiscal year, Medtronic, based in Ireland but with operating headquarters here, has had cash flow from operations of about $5 billion. So in addition to acquisitions and capital expenditures, it could easily afford to buy back stock.
The company also has a lot of debt, about $25 billion as of the end of the most recent quarter. Another reason why Medtronic chooses to carry a lot of debt and still buy back stock is that the money it borrows is cheap compared to the cost of shareholders’ equity, the most expensive form of capital. It’s not a good idea to let equity pile up.
By buying back stock with its cash flow, Medtronic is acting a little like a homeowner who has decided the family has too much capital tied up in his or her house. Rather than pay off the mortgage, the thing to do is refinance and use the extra money for other things.
“Spending” $500 million to buy back stock means the money is leaving Medtronic’s corporate checking account, but it’s not exactly being spent. It’s going into the accounts of investors who sold their shares.
The investors hopefully have a good idea of what to do with the cash. Maybe they fund an upstart business or invest in a growth company that’s starved for capital.
The one thing we know investors won’t do with the money is just sit on it.