Why share repurchases become a drug for companies.
Responding to questions about their capital allocation priorities, assistant treasurers at a recent NeuGroup meeting acknowledged “regurgitating the standard [capital] deployment line,” as one participant put it, after organic growth captured nearly half the votes and M&A ranked second.
Stock buybacks ranked last, even though much of the discussion ended up focusing on that use of capital, which may be a clearer indication of capital priorities. Key insights included:
- Like a drug. Returning capital to shareholders through stock repurchase programs often starts out as a way to dispose of leftover cash in a meaningful way. But soon the programs become a key element to achieve a targeted earnings-per-share (EPS), and then whatever remains becomes the leftover. “It’s like a drug that you can’t get off,” said a participant. “I’ve seen that in company after company.”
- Analysis of buybacks’ value varies greatly. One member said her team performs extensive analysis on whether share repurchases are providing adequate returns. Another member said that if repurchases are the last choice in capital deployment, then there’s not a lot of value from examining their returns, although some may want to maximize even the returns of leftovers.
- A signal to investors. For fast-growing companies, noted the assistant treasurer of a major technology firm, announcing that cash will go to repurchases instead of capex tells investors the company no longer has opportunities in which to invest, and its business model is changing.
- Downplaying repurchases. A company whose acquisition opportunities come in “chunks” may see repurchasing shares as a good way to return money to shareholders and even out cash levels. To downplay the importance of buybacks in managing their EPS, they may report earnings before share repurchases.
“They have that line item because that’s what they want investors to focus on,“ a member said.
S&P 500 as a benchmark. Several participants acknowledged their companies assume the money they return to shareholders will earn S&P 500-type returns, so if a company’s stock is outperforming the index, it should slow repurchases, and vice versa. One member prompted peals of laughter by asking whether anybody had ever heard their CFO say the company’s current share price made repurchases too expensive to continue.
Accountability for allocation decisions? Sort of. Responses to a survey question asking whether there is accountability for ensuring that capital allocations generate anticipated returns were 53% affirmative and 35% saying no.
But further discussion revealed that for most members, the answer rests somewhere in between. Their companies may have rigorous accountability policies, but given the long-term nature of significant investments, the relevant decision-makers often have left the company or are in very different positions. Monitoring too closely for accountability can stifle innovation.
