There's a funny thing about buybacks: when stocks are rising (and are therefore more expensive), companies have zero doubts about repurchasing their own stock, especially if said purchase is funded with cheap debt. Of course, by repurchasing their stock, the price goes even higher making management's equity-linked comp more valuable, which explains why management teams usually have no misgivings about allocating capital to this most simplistic of corporate uses of funds. However, when stocks fall, companies tend to clam down on buybacks due to fears that the drop may continue, forcing the CFO or Treasurer to explain his actions to the CEO or the board, and why they risked losses on capital (as well as getting a pink slip) instead of investing in "safer" corporate strategies like M&A, R&D or capex.
The irony, of course, is that companies should not be buying back stocks when the stock is rising (as that's when it is more expensive), and accelerate repurchases when it is dumping. And yet, that virtually never happens in reality as management teams, like most investors and algos, tend to chase momentum and direction. Meanwhile, confused by underlying pricing mechanics, management - which is singlehandedly responsible for the levitation in the stock price with its buybacks - then watches its stock price tumble even more one stock repurchases are halted.
But the "funniest" moments are reserved for when companies spent tens of billions on stock repurchases then had the rug pulled under from under the market - and their stocks - resulting in billions in unbooked losses on invested capital.
And in 2018, there has been no company that has had a greater share of "funny" buyback moments than Apple, which as we reported recently, accounted for 24% of all buyback growth in the first half of 2018, a year that will go down in history books for a record $1+ trillion in stock repurchase announcements and over $700 billion in executed buybacks.
The reason is that having spent tens of billions on buying back its own stock, Apple - the year's most aggressive stock repurchaser - has lost more than $9 billion this year on an underperforming investment: its own stock.
Like many large companies, Apple has used much of its windfall from 2017 tax reform to buyback shares. But, as so often happens, the recent plunge in stock prices has made that look like a bad idea. Apple and companies including Wells Fargo, Citigroup and Applied Materials repurchased their own shares at near record prices, only to see their value decline sharply.
In effect, the WSJ notes, "the market has told them they overpaid by billions of dollars." And nobody has been hit more by the plunge in overvalued Apple stock than Apple itself (and perhaps Warren Buffett).
While buyback advocates and companies contend that buybacks are a good way to return excess capital to shareholders and that the paper losses can reverse themselves if their stocks rebound, those advocates are clearly unfamiliar with the rise and fall - literally - of IBM stock in the period when the company would buy back its stock, and then after it no longer could as it had accumulated too much debt; additionally the sharp stock declines call into question their decision to devote so much of their tax savings to buybacks, rather than using it to invest in their businesses, raise employee pay or pay higher dividends.
"If they made an acquisition that decreased in value this much, people would be up in arms," Nell Minow, vice chairwoman of ValueEdge Advisors, told the WSJ. "They have one job, and that is to make good use of capital."
And, with a handful of exceptions, few companies have made worse use of capital than those who spent billions and billions on repurchasing their own stock this year: indeed, when the market was riding high, companies bought back shares at a furious pace, juiced by the tax savings they reaped from the December 2017 passage of the Tax Cuts and Jobs Act. The law enriched companies by slashing the corporate tax rate to 21% from 35% and making it easier for firms such as Apple to shift foreign earnings to the U.S.
S&P 500 companies bought back $583.4 billion worth of their own shares in the first nine months of 2018, according to S&P Dow Jones Indices, up 52.6% from the same period in 2017. As a result, nearly 18% of S&P 500 companies reduced their share counts by at least 4% year-over-year, according to S&P Dow Jones Indices.
Apple, having lost its vision to create "must have" gizmos and picking financial engineering instead, spent $62.9 billion on buybacks in the first nine months of 2018, according to securities filings.
But the subsequent selloff has pummeled its shares, and as a result the company’s repurchased shares were worth about $51.8 billion as of Thursday's trading, some $11 billion less than it paid for them as Apple repurchased shares at monthly average prices as high as $222.07, according to securities filings. The stock was trading at $151.27 on Thursday.
Apple advocates were quick to defend the company:
Apple makes iPhones. Timing the market is not what they do,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. Companies that try to time the market in buying back shares “are going to be in the red at times.”
Still, with Apple promising to invest $30 billion in the US and create 20,000 US jobs over the next five years, that's $10 billion the company could have used toward said noble goal instead of providing a one-time transitory boost for its shareholders.
To be fair, it's not just Apple as some big banks have encountered the same issue. Wells Fargo spent about $13.3 billion on buybacks from January through September for shares now worth $10.6 billion, about $2.7 billion less than they paid. Citigroup spent $9.9 billion on buybacks in the nine-month period for shares now worth about $7.1 billion, about $2.8 billion less.
As the WSJ notes, both banks bought back some shares at monthly average prices that weren’t far below their 52-week highs, and both companies’ share prices have fallen well below those levels. Wells and Citigroup declined to comment, although it would be interesting to hear their thoughts on why they were buying back stock at multi-year highs instead of saving the dry powder for when the stocks dropped... Unless, of course, the stocks would never have been near 52 week highs if it weren't for the buybacks (spoiler alert: that's exactly the case).
Other tech companies were also sucked in by the siren song of rapid stock price appreciation and Applied Materials spent $4.5 billion for shares now worth $2.7 billion—about $1.8 billion less. The stock has declined 40% this year. Applied Materials bought back many of its shares for prices above $50; the stock closed Wednesday at $30.64.
And as noted above, now that the market is sliding and many of these stocks are tumbling, management teams have suddenly stopped repurchasing shares. Furthermore, while it is possible some companies may take advantage of the currently beaten-down prices to buy back more shares, many companies are heading into their pre-earnings blackout period, when they can’t buy back stock because they know what their forthcoming quarterly earnings will look like.
And companies remain nervous about the volatility in stock prices, Mr. Silverblatt said. “It’s hard to fight the market."
In other words, the math is simple: corporate buybacks are no better timers than the average retail investor who buys near the all time high, and then sit quietly when the stock is tumbling and they should be buying.
But the bigger question is whether Apple has been shamed enough into halting buybacks for good. If so, watch out for the news that Warren Buffett has sold his entire investment, which he only made expecting to frontrun AAPL management... exactly the same reason why he bought IBM when he did, and why he dumped it at a major loss a few years later when IBM management made it clear it was done spending billions on stock repurchases.