Money Research Collective’s editorial team solely created this content. Opinions are their own, but compensation and in-depth research determine where and how companies may appear. Many featured companies advertise with us. How we make money.
What the Boom in Stock Buybacks Means for Investors
By Pete Grieve MONEY RESEARCH COLLECTIVE
Stock buybacks hit a record high in 2022.
***Money is not a client of any investment adviser featured on this page. The information provided on this page is for educational purposes only and is not intended as investment advice. Money does not offer advisory services.***
Companies are buying back their own stock at a rapid clip despite a new tax meant to discourage them.
Stock buybacks are a way for companies to return profits to shareholders, but they’re controversial. This boom in buybacks comes amid a 1% tax on them that went into effect at the beginning of this year.
Here’s what investors need to know about stock buybacks and how they impact stock prices.
Why do companies buy back their own stock?
Companies buy back shares they previously sold as a way to return money to shareholders, similar to how they use dividends to reward investors. (Unlike dividends, which are usually paid quarterly, buybacks can be a one-off move.)
“Investors put up money [and] they expect the company to use those resources wisely, create some value and give some of that back to the shareholders,” says James Angel, finance professor at Georgetown University.
When making decisions about buybacks and dividends, companies have to consider other ways they could use the money and the growth that they would expect to achieve if they pursue those alternatives as opposed to repurchasing stock, Angel says. For example, instead of buybacks, they could hire more employees, invest in research or buy smaller companies.
“If they have more money than they actually have good growth opportunities, then they should return it to the shareholders,” Angel says.
Critics of the practice say that companies should use their profits to make long-term investments instead of rewarding shareholders with buybacks. President Joe Biden signed a law in August that added a 1% tax that companies have to pay on buybacks — but it doesn’t appear to be deterring them. Even with the new law, Angel says “it’s much more tax efficient to give money to your shareholders with a buyback than it is with a dividend.”
In most cases, dividends are taxed as income, but investors only incur taxes after buybacks if they sell their shares at a higher price and pay capital gains.
Biden said during his recent State of the Union that he wants to raise the buyback tax to 4%, and several Democratic senators introduced a bill to do so last week.
What stock buybacks mean for investors
After a buyback, a company’s share price is almost inevitably going to rise, at least in the short term, because buybacks create a shift in the supply and demand for the stock, Silverblatt says.
Here’s a hypothetical example: There are 100 shares of a company trading on the public market and each share is worth $10. When a company buys some of its own shares, fewer shares are then on the public market and available to buy, which means those remaining shares are now worth more than $10.
Markets normally interpret buybacks as good news because they show that companies believe in themselves, he adds.