WEBVTT

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There's a battle brewing over stock
buybacks.

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Last year,
more than $922 billion was spent

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on corporate buybacks,
setting a new annual record.

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The increased use of share

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repurchases has drawn the attention
of both politicians and regulators.

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President Joe Biden singled them out
at his recent State of the Union address.

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That's why I propose
we quadruple the tax on corporate stock

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buybacks and encourage long-term
investments.

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And business groups are going to court
to block new disclosure rules

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on share repurchases.

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On this IBD Explains,
we ask: What are stock buybacks

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and what are some of the pros and cons
driving the current debate?

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And here with me to help break things down

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is IBD's own personal
finance and management editor Matt Krantz.

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So, Matt, what are stock buybacks
and why do companies use them?

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Yes, companies make money.

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They have profit, and with the profit
they can do three things.

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They can give it back to shareholders
in the form of a dividend,

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which is great
because everyone loves free money.

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They can plow it back into the business,
buy new equipment, buy the machines, buy

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more capital goods,
or they can do a stock buyback.

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A stock buyback is basically
when they take the profit and they buy

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the shares of their own company.

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And you might wonder
why would you ever want to do that?

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And there's a couple of reasons
why they might do it.

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One reason is they can't figure out
any better place to put it.

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Another good reason to do it is because
dividends are taxed at a higher rate.

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So if you pay a dividend,
you get to pay a tax on it.

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There is a tax on buybacks,
but it's not as high.

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And it's also another great way
for existing shareholders

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to own a bigger piece of the company.

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And we've seen a lot of debate around
buybacks lately.

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Apple
was the latest company to do this, but

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they seemed to draw a little bit of ire
from the public.

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We have this proposal
to start taxing these share repurchases.

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So why the anger around this?

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And are buybacks good business
or is it just a sign of greed

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or possibly an underlying issue
going on with a company's financials?

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That's a great question.

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So basically, everybody wants
the extra profit that companies generate.

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So employees want it.

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They want they want a fancy new office
building or they want

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more higher salaries.

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They want the money coming to them.

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The politicians
want the money coming to them.

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And if they pay dividends
with the extra money,

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they get paid tax on the dividends
by the shareholders.

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But with the share buybacks,
the regulators don't

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get the taxes and the employees
don't get the fancy headquarters.

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The money goes back to the shareholders
and that kind of upsets people.

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Some extreme cases are
when you have like the recent catastrophe

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with the trucking industry
and the rail industry,

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people get upset because they say,
why did you use that money to buyback

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your stock? Why didn't you use it

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to improve the safety of your
of your products and services?

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So that's a legitimate point.

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Yeah, you mentioned the rail companies
because those obviously have been around

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for a much longer time,
but we've maybe seen some research

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that younger growth companies tend to plow

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their money back into the business
and maybe more mature companies

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see buybacks as the optimal way to use
the surplus cash.

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Is there a difference
how this money is being used

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based on
how long the company has been around?

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Yeah,
sometimes that's a really good point.

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So a younger company
can't really afford to be paying off

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big dividends or buying back
a lot of stock they need every time

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they can to put into the business
to create new products and services.

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With that said, even some older companies
like Berkshire Hathaway, Warren

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Buffett's company,
he doesn't pay a dime in dividends

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and he's reluctant to do buybacks as well.

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With that said, an older company,

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it's really a good way
to attract investors with stock buybacks

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because it's a way
to get the money back to the investors

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and they want return to a smaller
growing company.

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A buyback is really the only way
to get a return or a dividend.

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So it comes down to those two things.

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And you mentioned how shareholders
can benefit from these buybacks,

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but are there any potential downsides that
can come from these share repurchases?

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Yeah, there is.

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So the way to think of it is what the
when there's a buyback, basically

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the company's taking the pie
and let's say it's cut into six pieces.

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They're actually buying back slices

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so that it'll be cut into four sites
and see your slices bigger.

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So that's great.

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But the problem is at what cost?

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So there's a couple of things
that can happen.

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One thing
the company can forego investments that it

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really should be making in its business.

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And this is really important
and we saw this in the newspaper industry.

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They were paying back dividends
and doing buybacks.

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And it was great for a while.

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And then it turned out that they got
completely decimated by the Internet.

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So they really should have been taking
some of that money

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and talking back to the business
because it was kind of shortsighted.

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The other problem it can cause
is with executive compensation.

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So most executive compensation
packages are tied to the stock price

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and it works great
until there's a buyback.

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When there's a buyback, it
distorts all the metrics

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so it makes the executive deserve a raise,

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even if they didn't earn it
just because of the optics of the buyback.

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So there are there are drawbacks. Yeah.

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So it seems like if you're an investor
looking at a potential company, you know,

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it all comes down to that, that management
and stewardship of the finances there.

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Absolutely.

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And but with that said,
the buyback is great.

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And until there's a problem,
if a company is balancing the three stores

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properly, investing in its business,
doing the dividends,

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buybacks are a great tool

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because they get money back
to the shareholders in an indirect way

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so you don't have to pay tax on it
and that's really great

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because there can be double taxation
in the form of some dividends.

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So, you know, I hate to see the buybacks
as being demonized.

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I think it may have been overused
in some cases.

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It's not perfect,
but it is a great tool for investors.

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Yeah,
and talking about that tool for investors,

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do you have to sell your shares
in a buyback to get those gains?

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That's a good question.
So let's go back to the pie example.

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Let's say that the pie has six pieces
before they do buyback.

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It now has four slices. So this is great.

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Your slice of pie is bigger than it was,
but to enjoy

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it, you're going to have to eat it
and to eat it, you have to sell it.

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So it's kind of a
I'm answering your question both ways.

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You do benefit in the fact before you sell
your slice of pie is larger,

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but to actually get the money,
you do have to sell it.

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Well,
thank you so much for your insights today.

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Thanks a lot for having me.