Corporate America finds itself in a situation of abundant cash reserves and is currently engaging in an almost unprecedented level of stock buybacks. President Biden aims to adjust the tax policies concerning these buybacks.
According to reports, in his upcoming State of the Union address, President Biden will propose an increase in the tax rate applied to companies when they repurchase their stock, raising it from 1% to 4%.
The underlying rationale behind this proposal is to incentivize companies to allocate their resources differently: instead of prioritizing stock buybacks, they would be encouraged to invest in expanding their workforce or in capital expenditures such as new infrastructure, buildings, or technology.
While the effectiveness of this approach remains a subject of debate, there is a clear trend of companies diving into buyback activities. Many analysts predict that 2024 could witness buyback levels reaching close to historical highs.
The surge in buybacks can be attributed to various factors. Following a remarkable 2022, during which $950 billion worth of stocks were repurchased, 2023 experienced a downturn, largely due to limited earnings growth. However, projections for 2024 and 2025 indicate a return to near-record levels.
According to data from Goldman Sachs, the trajectory of buybacks illustrates this trend:
– 2024 (estimated): $925 billion
– 2023: $815 billion
– 2022: $950 billion
– 2021: $919 billion
– 2020: $538 billion
– 2019: $749 billion
Jeffrey Yale Rubin of Birinyi Associates highlights that in February alone, companies announced $187 billion in buybacks, marking the second-highest figure after the record set in February 2022, at $225 billion.
Goldman Sachs, in a recent report, emphasized that robust earnings growth serves as the primary catalyst for buybacks, while elevated valuations and policy uncertainties pose potential challenges.
In line with this optimistic outlook, Goldman revised its buyback forecasts, projecting $925 billion for 2024 (a 13% increase year-over-year) and $1.075 trillion for 2025 (a 16% increase year-over-year).
Furthermore, Goldman pointed out that a significant portion of these buybacks stems from the remarkable profitability of major tech companies. The bank stated, “We anticipate that the mega-cap tech stocks will primarily drive buyback growth in 2024.”
Goldman also highlighted that the seven largest tech companies alone accounted for 26% of S&P 500 repurchases in 2023, underscoring the significant role of tech giants in driving the buyback surge.
Corporations have significant flexibility in how they allocate their generated cash flow. Typically, surplus cash is allocated across three main categories: buybacks, dividends, and capital expenditures. While the allocation to each category fluctuates over time, recent trends have shown a preference for buybacks.
In 2023, the breakdown of cash flow allocation in Corporate America was as follows:
– Buybacks: $765 billion
– Capital expenditures: $597 billion
– Dividends: $588 billion
(Source: S&P Global)
The rationale behind the emphasis on buybacks lies in their potential to enhance share prices. By reducing the number of shares outstanding, buybacks theoretically improve earnings per share.
Dividends, however, serve as an alternative means of returning shareholder funds. Interestingly, some major tech companies seem to be shifting towards this approach.
For instance, alongside a recent buyback announcement, Meta Platforms, the parent company of Instagram, declared its inaugural dividend. Notably, three of the “Magnificent 7” tech giants—Alphabet, Amazon, and Tesla—do not currently offer dividends.
According to findings from Goldman Sachs, large companies characterized by stable earnings, high-profit margins, and attractive valuations are more inclined to initiate dividends. Applying this framework, they identified Alphabet and Amazon as ranking first and eighth in terms of likelihood among stocks in the Russell 3000 Index to commence dividend payments.
The possibility of companies redirecting their surplus cash towards increased capital spending and bolstering hiring in response to higher buyback taxes remains uncertain. Particularly for major tech companies, such decisions are more likely to be influenced by the pace of technological advancement rather than solely by tax considerations.
In 2023, the “Magnificent 7” tech giants collectively allocated $407 billion towards capital expenditures and research and development, accounting for 23% of their annual revenue and 27% of all S&P 500 spending in these areas.
Goldman Sachs highlighted that if management perceives attractive investment opportunities beyond the current level of expenditure growth, they may opt to curtail buyback programs to facilitate such investments.
Moreover, the decision between different cash allocation strategies often hinges on broader economic conditions. Higher economic growth typically prompts companies to invest more in expanding their workforce and capital infrastructure.
Goldman Sachs’ economic outlook suggests a potential slowdown in economic growth in the latter half of 2024, indicating a continued preference among investors for companies returning cash to shareholders. However, if economic momentum continues to strengthen, there may be a shift towards rewarding companies that prioritize growth investments.
Here the question is: Would higher taxes on buybacks deter companies from engaging in such activities?
In early February, Meta Platforms authorized a $50 billion expansion of its share buyback program, equivalent to approximately 5% of outstanding shares at the time. Under the existing tax regime, the company would incur a $500 million tax liability, whereas under President Biden’s proposed tax plan, this amount would increase to $2 billion.
While this represents a substantial sum, it remains unclear whether it would prompt Meta Platforms to reallocate funds from buybacks to capital investments.
Howard Silverblatt, senior index analyst at S&P Global, emphasized that there is insufficient evidence to suggest that taxing buybacks would compel corporations to divert funds toward capital expenditures.
He concurred with Goldman’s analysis, suggesting that corporations would logically prioritize investments in hiring and capital expenditures if economic growth persists: “That is what they should be doing, aligning their resources with areas of growth,” he stated.
