Last week, Apple, Inc. reported quarterly earnings and revenue that beat analysts’ expectations. Stock share prices increased as the company increased its dividend by 16%. That same day the company announced it would be buying back $100 billion in shares from investors. This is about 11% of Apple’s market cap.
When companies have a cash hoard, investors and analysts alike look to management to see what they will do with their money. Most like to see companies invest in research and development or acquire other companies. Sometimes management decides that they want to share the wealth with investors by increasing the dividend and buying back shares.
The financial theory is that any monies given back to the investor is generally considered a plus whether it be in the form of dividends or share buybacks. But companies know once they raise dividends, they cannot cut dividends in the future without negatively affecting the stock. The perception of a dividend cut is that the company has fallen on hard times. On the other hand, a stock buyback program is a signal to investors that management believes their stock is undervalued in the market. A company’s management knows better than anyone else what is in the pipeline for the company. A stock buyback can be a vote of confidence from management, but also consider a counter argument, it can also indicate that management doesn’t know what to do with money.
A company “increases” earnings per share through a stock buyback without actually having to increase a company’s earnings. It’s simple math, because now there are less shares to divide earnings among—it is a redistribution of existing wealth. This artificial boost in financial ratios can help a CEO meet performance metrics; however, it also generally tends to send the company’s stock price higher. Short-term investors may look to make quick money by investing in a company before an announced buyback. Share buybacks also help management keep the number of shares outstanding at a steady level after issuing shares for employee compensation.
Conversely, when companies issue stock buybacks it can raise concerns that growth is stagnating; therefore, instead of investing in R&D, they’re buying back shares. It can raise the questions of why a company is using their cash this way versus acquiring growth or investing in the next product cycle. There are always some investors and analysts who would rather see money go back into company than back to investors. This sentiment is especially seen in growth engines like the Technology sector. A buyback may signal to some that a company doesn’t have any growth aspirations or opportunities, and as a result, share price can fall.
As long-term investors, we prefer to see companies invest in more innovation, research and development and new product offerings. However, if a CEO sits on a cash hoard for too long waiting for an opportunity to invest in growth, both analysts and investors will ask when the company is going to put that cash to work. In Apple’s case, the money being used for the share buyback came from money the company originally held abroad and can now repatriate thanks to the tax reform laws for corporations.
Overall, a stock buyback can be seen as a way to please shareholders while showing that management believes in the company’s future, but investors should always look at the underlying motives. If you have questions regarding one of your holdings’ stock buyback announcements, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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