The Beauty of Stock Buybacks
I confess, I’m not a big fan of socialists… or ultra-liberal Democrats who behave like socialists.
I often disagree with just about everything they say. But I was especially taken aback by Sen. Elizabeth Warren’s view of stock buybacks.
Her view, as evidenced in the quote above, is just plain wrong!
But don’t take my word for it; here is what Warren Buffett says about stock buybacks: “From the standpoint of existing shareholders, repurchases are always a plus.”
Stock BuyBacks — Always a Plus!
If buybacks are always a plus, then stock investors should expect the stock market to keep going higher. I say that because of the surge in share buybacks this year.
U.S. companies bought back $436 billion of stock in the second quarter of 2018, a new record. This brings the first half-year total to $670 billion.
Better yet, the total value of stock buybacks is expected to exceed $1 trillion this year, which would trounce all prior records.
The fuel behind the buyback boom was the passage of the Trump tax cuts, which lowered the taxes on foreign income as well as lowered the corporate tax rate from 35% to 21%.
With $2.6 trillion of American profits still sitting overseas, the buyback boom isn’t going to end anytime soon. I expect corporations to further escalate their share buybacks this year and next.
Keep in mind too that companies don’t buy back their stock unless they consider it to be a good value. History has shown companies engaged in stock buybacks are good investments.
According to a study from Harvard Business Review, companies that buy back their own stock see their stock increase by 12.15% versus their nonbuyback peers over the next four years.
In short, stock buybacks create value.
Source: S&P 500/Dow Indices, Morgan Stanley, Bloomberg
The reason for the outperformance is simple. Buybacks decrease the number of outstanding shares, and the result is profits are spread over a smaller number of shares. This increases earnings per share (EPS).
DWBD: Do What Buffett Does
I mentioned Warren Buffett at the top of this article because he thinks buybacks are such a good idea that he’s jumping on the bandwagon too.
Berkshire Hathaway recently eliminated an old rule that it could only buy back shares if they were selling for less than 20% above book value.
However, Buffett can now permit share buybacks anytime he and co-manager Charlie Munger feel Berkshire Hathaway is trading below their estimate of its intrinsic value.
As of the end of the first quarter, the book value for a Berkshire Hathaway share was $211,184, but its price was around $300,000, 40% above book value. This means Berkshire was prohibited from buying the stock under the old rule.
Today, Berkshire Hathaway has more than $108 billion in cash, so I wouldn’t be the least bit surprised to hear a massive stock buyback announcement from Berkshire Hathaway at any time.
And what do you think will happen to the stock market when the Oracle of Omaha does just that?
You got it… higher stock prices.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch