Battered by months of disappointing sales, networking giant Cisco needed a way to give its shareholders a pick-me-up. So the San Jose, Calif.-based firm did what has become routine for many big U.S. companies in a slow-growing economy: It announced last month that it was buying back shares of its stock.
The amount authorized to be spent was $15 billion, surpassing the $10 billion in net income the company earned last year. It’s also 2.5 times what Cisco spent on research and development, and comes as Cisco lays off 5 percent of its workforce, or 4,000 employees.
This is what U.S. multinationals do now with their cash. Rather than tout big new investments, raise worker wages or hire more employees, companies are more likely to set aside funds to reward shareholders – a trend that took a dip during the recession but has roared back during the recovery.
The 30 companies listed on the Dow Jones industrial average have authorized $211 billion in 2013, according to data from Birinyi Associates, helping to lift the benchmark stock index to heights not seen since the late 1990s tech boom. By comparison, the amount is nearly three times what the group spent on research and development last year, according to data from S&P Capital IQ.
Why spend so much on stock repurchasing? By reducing the number of shares outstanding, the value of each one goes up, a way of instantly rewarding shareholders.
The repurchase also lifts earnings per share, an important number closely watched by investors – and by corporate boards to determine executive pay. Of the companies making up the Dow 30, all but four list earnings per share in their public documents as a metric used to determine executive pay.
Ultimately, analysts say, when companies spend money on buybacks rather than investment, they’re signaling low hopes for economic growth. “Corporate profits are very high, but corporations are not expecting a huge burst of growth,” said Ben Inker, co-head of asset allocation at GMO, an investment management firm. “Given that they’re not expecting a lot of growth, there isn’t a lot of reason to invest. So they’re finding ways of getting money back to shareholders.”
The types of companies that authorize buybacks transcend industry. Among the Dow 30, more than half have approved stock buybacks this year, essentially earmarking money for repurchases that can take place over years. In February, Home Depot authorized $17 billion; Goldman Sachs signed off on $10.8 billion in April; Pfizer green-lighted $10 billion in June; and Wal-Mart authorized $15 billion in June.
The announcements often come on top of ongoing share repurchases that outpace spending on research and development. AT&T, for instance, has spent $11.1 billion this year buying back shares, compared with the $1.3 billion it spent last year on research and development. Pfizer has used $11.5 billion to repurchase shares; the pharmaceutical company logged $7.9 billion in research last year.
Cisco spokeswoman Kristin Carvell said the company has not announced a timeframe for completing the $15 billion buyback, so evaluating the size of the authorization next to annual net income is “not necessarily a direct comparison.”
She rejected the idea that the company is authorizing buybacks because it doesn’t see investment opportunities. Carvell said Cisco is able to do both: return cash to shareholders and make investments. Carvell also said that the recent layoffs were not done to cut operational costs but to allow the company to invest in “key growth areas.”
Cisco announced its buyback authorization the same day it released disappointing quarterly earnings. The bad news outweighed the repurchase declaration and sent the stock down 11 percent.
Part of playbook
In the past three decades, the stock buyback has become a standard move in the playbook of corporate America, echoing the growing fixation on maximizing shareholder value that has swept C-suites.
The rise of share buybacks reflects a belief that a company’s primary purpose is to return value to shareholders, even though that principle is not codified by U.S. statute.
Helping to fuel the market’s meteoric rise is the Federal Reserve’s stimulus program designed to lower borrowing costs. Companies are taking advantage, often by borrowing money at low rates to repurchase shares, although it’s unclear how much of the debt is being used to pay for buybacks. “It somehow feels scarier if they borrowed the money to buy back stock than if they had some investment opportunities,” Inker said. “That somehow seems more sustainable than just levering up to reduce the share count.”
Some say companies are better off repurchasing shares than pouring money into investments promising dubious payoffs, especially in a slow-growing economy. But others argue the rise of the buyback is encouraging executives to make decisions that aren’t always good for their firms or the economy, rewarding companies for finding quick ways to please shareholders, rather than innovating and planning for long-term growth.
“It’s not just the money,” William Lazonick, professor of economics and director of the University of Massachusetts Center for Industrial Competitiveness, said of buybacks. “It changes the strategy of the company. It undermines innovation.”
Share buybacks weren’t always a fixture in corporate America. In 1985, only 52 stock repurchases were authorized, according to Birinyi Associates. This year, there have been 885. Buybacks at all companies this year are on track to reach $754 billion, shy of the $863 billion record set in 2007 but far above the 2009 low, during the recession.
Lazonick traces the rise of buybacks to a rule passed by the Securities and Exchange Commission in 1982 that gave “safe harbor” to corporations repurchasing large parcels of stock – a way to protect them from charges of price manipulation. “It’s systemic,” Lazonick said. “One company does it, everybody feels compelled to do it. Otherwise their stock price will lag behind.”
Tied to exec pay
Another factor, experts say, is that executive pay is increasingly tied to movements in the stock market as corporate boards try to tie pay to performance. And often, the compensation itself comes in the form of stock.
The use of restricted stock grants to pay executives hit an all-time high in 2012, according to research firm Equilar, with 93 percent of S&P 1500 companies granting restricted stock to employees, compared with 80 percent in 2007. But some corporate governance experts question why pay is so closely tied to share prices and metrics such as earnings per share, which executives can so easily alter in the short term.
As the stock market has surged, executive pay has shot back up as well. Equilar found that chief-executive compensation is “growing at levels last seen prior to the recession,” according to its 2013 report on chief-executive pay strategies. Meanwhile, average worker pay has remained stagnant since before the crisis.