As several high-profile Democratic presidential candidates make restricting stock buybacks a new political issue, Goldman Sachs is weighing in with a detailed argument on why restrictions, never mind an outright ban, would be bad for the stock market. The negative consequences include distorting investment decisions, lowering valuations and depressing share prices, the firm says.
Goldman's views are outlined in both the table and detailed article below.
5 Ways A Buyback Ban Could Damage The Market
- Sharply slower EPS growth
- Increased spending on dividends, M&A, and debt reduction, but not on capex
- Increased dispersion of stock returns and higher market volatility
- Reduced demand for shares, causing prices to weaken
- Lowered corporate valuations, also causing stock prices to weaken
Source: Goldman Sachs US Weekly Kickstart Report, April 5, 2019
Significance For Investors
Slower EPS growth. Goldman's first big concern is slowing earnings growth. "Buybacks boost earnings per share by reducing the number of shares outstanding," Goldman notes. As a result, EPS have grown more rapidly than bottom line earnings for the median S&P 500 company over the past 15 years. Since stock prices are partly driven by EPS, restricting or eliminating buybacks going forward would slow the potential increase in stock prices, hurting all investors, Goldman argues.
No boost in R&D or capital investment. While anti-buyback politicians say a ban will increase capital investment and R&D, Goldman says this is highly unlikely. "Investment spending has always the first priority for corporations," Goldman observes, noting that, over the last decade, the S&P 500 companies have used 45% of their cash spending and 8% of their sales revenues to reinvest in their businesses. Without new, additional investment opportunities, firms are unlikely to spend more than 8% of sales on capex and R&D, Goldman adds.
Since 2009, 25% of total cash outlays by S&P 500 companies have been on buybacks. Rather than increasing capex and R&D, a buyback ban might cause some companies to retire stock by making formal tender offers for their shares. Or, they may increase dividends or spend more on mergers and acquisitions.
Higher stock market volatility and sharper market declines. Reducing buybacks could aggravate market upheaval and volatility. "Prohibiting buybacks would reduce downside support for equity prices since companies could no longer step in to repurchase shares if their stock prices tumble."
Lower demand for shares. "Repurchases have consistently been the largest source of US equity demand. Since 2010, corporate demand for shares has far exceeded investor demand from all other investor categories combined." Goldman calculates that corporate buyback activity represented more than 90% of the net purchases of U.S. stocks in the last nine years.
Lower stock valuations. Slower EPS growth is likely to result in lower forward P/E ratios, which reflect expectations of future growth. Prohibiting buybacks could also apply downward pressure on equity prices if it increases the supply of equities relative to demand at current prices, the report adds.
Wall Street banks, including Goldman, have been among those companies that have benefitted most from the 10-year bull market and thus have much to lose in any curbing of buybacks. That's why the battle is intensifying as the U.S. Senate convenes hearings on a bill that would prohibit public companies from buying their shares on the open market. Anti-buyback politicians say that share repurchases mainly serve to enrich wealthy shareholders at the expense of ordinary citizens. However, with Republicans in control of the Senate and the White House through 2020, the odds are slim that an anti-buyback bill will become law soon.