Stock buybacks surge but taxes could impact their returns

Companies have a couple options when it comes to spending their excess cash including:

• Capital expenditures — buying new equipment or buildings.
• Dividends — providing cash payments to investors.
• Stock buybacks — repurchasing their own stock on the market.

US businesses are cash-rich thanks to strong earnings and cheap debt — with S&P 500 companies holding $3.7B in cash and cash equivalents at the end of the second quarter.

• Given the uncertain economy, companies have bought back more shares instead of spending cash on capital expenditures.
• Several companies including Microsoft, McDonald’s and Dell have announced or restarted large buyback plans in the past month.

Impact on stocks: Buybacks are seen as good for stocks — decreasing the number of shares available to investors which should increase stock prices (supply and demand). They also signal confidence in a company’s own business — or that their shares may be undervalued.

The case against buybacks: Some investors prefer companies reinvesting cash back into growth. By choosing buybacks or dividends, some see the company as having no better place to use their cash.

• Investors rarely see growth stocks issue dividends or buybacks but as companies grow, they allocate more money in these areas.
• The top 20 companies in the S&P 500 made up 55.7% of buybacks in the second quarter of 2021.

Proposed tax changes: Unlike dividends, companies are not taxed on buybacks but the Democrats are considering taxing them to fund their big-spending packages.

• If taxes on buybacks are enforced, companies that buy back stock could see slightly lower performance compared to those that don’t.
• Money managers argue that taxes would have little impact on stock prices.