When Did Share Repurchases Become a Crime?

Ten years ago, I did a lot of investing into individual stocks. While my investing these days is mostly limited to mutual funds, one thing that always attracted me was when a company bought back shares of their own stocks. To me, this always signaled confidence in the company, and a belief from insiders that the stock would perform well in the near future. While there are some who feel that stock buy backs are what companies do when they don’t have very good investment prospects for their cash on hand, share repurchases always made perfect sense to me. If I were the CEO of a company, and I felt like my company was undervalued, share buy backs are going to be one way of enhancing shareholder value.

Yet the stock buy backs from Big Oil are often talked about as if they were reprehensible:

Congressional panel takes Big Oil to task

“Oil companies today are enjoying record profits, and while they could use those profits to invest in more production capacity, instead they use the money to buy back shares in the markets,” complained Rep. John Conyers Jr., D-Mich., the panel’s chairman.

Oil Companies Manipulate Markets and Gouge Consumers

High energy prices are translating directly into record oil company profits. In the first six months of 2006, the five largest U.S. oil companies posted $59.4 billion in profits. These companies have spent $112 billion since 2005 to buy back their own stock and pay dividends rather than invest in infrastructure or alternative energy sources, according to analysis done by Public Citizen.

Big Oil cautious about clean-energy spending

The amounts that oil companies invest in alternative energy typically pale in comparison to some of their other expenditures.

Exxon spent $19.9 billion in 2006 on capital expenses and the hunt for more oil. It also paid $29.6 billion to buy back some of its own stock, a move meant to reward investors by increasing the value of outstanding shares. The company’s annual profit hit $39.5 billion, the most ever for an American company.

Chevron spent $16.6 billion in 2006 on exploration and capital expenses, which include maintaining refineries, pipelines and other facilities worldwide. The company spent $5 billion on buying back stock. Chevron made a $17.1 billion profit for the year.

ConocoPhillips spent $16.3 billion on exploration and capital expenses, and $925 million on buying back stock. The company’s 2006 profit topped $15.5 billion.

Yet if Home Depot or Best Buy announce stock buy backs, there is no public outcry. CNN’s take on it is more to my liking. In the wake of ConocoPhillips’ announcement yesterday of a $15 billion share buy back, CNN wrote the following:

Buyback Announcements Are Bullish For Market

Shareholders of two blue-chip companies, as well as investors generally, were treated Monday to a bit of good news that carries potentially bullish long-term consequences.

First, Johnson & Johnson (JNJ) announced that its board of directors had authorized the repurchase of up to $10 billion of its common stock.

Then, later in Monday’s trading session, ConocoPhillips (COP) announced that its board had approved a $15 billion share buyback program, representing an increase of $13 billion above and beyond the $2 billion that remained in a previous buyback program.

These announcements are good news because the average company that repurchases its shares outperforms the market by an annualized average of 3.1% over the four years following the announcement of its share repurchase program. That’s the finding of perhaps the most comprehensive academic study of repurchase programs, which appeared in the Journal of Financial Economics.

Why would repurchases carry such bullish potential? One theory explains it in terms of simple supply and demand: Repurchases reduce the supply of a company’s stock outstanding, which according to Economics 101 should increase the price of those shares that remain.

Another theory: Companies that repurchase their shares are so confident about their future prospects that they are willing to commit corporate resources to buying them. This is worth paying attention to, since a company’s executives and Board of Directors have access to insider information that the rest of us do not.

I am sure we will be treated to a lot of negative stories about the COP buy back, but I don’t suspect the same is true of the J&J buy back. That will be viewed as a shrewd move by their CEO.

7 thoughts on “When Did Share Repurchases Become a Crime?”

  1. Unlike you or I, companies can’t just sit on piles of money that it earns. They have to buy down debt, reinvest, return to shareholders as dividends or buy back stock. Back in the 1980s the IRS pressured oil companies to spend their money. Finding few places in the oil and gas sectors, Exxon purchased the office products division of Xerox, Mobil bought Montgomery Wards, other companies made similar investments. They didn’t work out to well.

    This also signals to the investment community that companies believe that traditional capital growth is overpriced.

    I have been thinking that the IOCs need to take themselves private. That would really drive some people crazy!

  2. Really, what else are they (the big majors) going to do with the money?

    Rig utilization is as close to 100% as you can get –e.g., Transocean has everything they own punching holes in the ocean floor. They’ve got several new contstuctions going on.

    So they can bid up dayrates (which, as a stockholder in NE and RIG, fully support!) or they can contract for even more new construction which will come online in about 2012.

    If Congressman Conyers and Public Citizen think that it is such a good idea invest in “more production capacity” or alternative energy (whatever that is today), it’s a free country — go for it, invest your own money, but not my tax dollars.

    They need to put their own money where their mouth is.

  3. To some extent, share buybacks are an admission that a company cannot find projects that offer a better multiple than the multiple assigned to their own stock. If they could find such projects, then by investing in them presumably they could make the share price rise over time. On the other hand, investing in projects with a lower return would reduce the share price, so returning that money to the owners of the company makes more sense. Given the way dividends are taxed versus capital gains, it make more sense to return money through stock repurchases than through higher dividends. Owners can then decide for themselves how much cash (and tax) they want by deciding to sell (or not sell) shares.

    I have to agree with Jon re. the investments Conyers and others think they should be making. Let’s face it most of the world’s reserves are in the hands of governments like Venezuela that are kicking our companies out. And I’m sure Conyers doesn’t want them drilling more here at home. So where exactly does he think they should be investing? “Alternative” energy? The world is awash in cheap capital right now, so if those projects were such great investments, they would already be attracting the capital they deserve (and many are from VCs etc.) Conyers is free to put his money into alternative energy mutual funds if he likes – so is everyone else.

    I think Conyers, Schumer and others would like to have the oil business run on a utility model. But they can’t have it both ways – the utility model has to guarantee a certain level of profit.

  4. To some extent, share buybacks are an admission that a company cannot find projects that offer a better multiple than the multiple assigned to their own stock.

    Or, that you think the multiple assigned to it does not reflect the true value, and that you are buying those shares back at a bargain price.

  5. Well, of course the phony whine about oilcos buying back their stock is simply nonsense — but, on the other hand, whining about such nonsense is …?

    People hate oilcos, because they are addicted to the product and hate having something so central to their life and identity in the control of others. Unwilling to deal with the consequences of breaking their addiction, they lash out at the supplier.

  6. As a shareholder, I’m very suspicious of stock repurchases. If the company CEOs and management hold options, repurchases is simply a way for them to cheat the shareholders of money that would otherwise be paid out as dividend.

    I agree that buying back stock is the ideal way to spend money if the stock is undervalued, but I feel that buyback programs and options should never exist at the same time in the same company.

  7. Mriswith, isn’t that reverse dilution, which increases shareholder value by removing outstanding shares from circulation? And better still, doesn’t that prevent the shareholders from having to report income on dividends, instead plumping share prices?

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