67 Percent Of Corporate Buybacks Used To Offset Employee Stock Dilution

The significance is that both employee equity compensation and stock buybacks are as much forms of hedging as of rewards. JL


Michael Batnick reports in the Irrelevant Investor and Barry Ritholtz reports in The Big Picture:

Buybacks are misunderstood both by politicians who argue that it exacerbates income inequality, and bears who argue that it is manipulating the market higher. “Most companies don’t view buybacks as a means of returning cash to shareholders but as offsetting the dilution caused by stock compensation. The source of funds for most stock buybacks is the employee compensation expense item on corporate income statements.” “The current source for equity issuance data in the Financial Accounts of the United States does not fully incorporate issuance to employees by public corporations.”

The Irrelevant Investor Apparently, the most commonly cited data on buybacks isn’t accurate. Yes, you read this right. The data doesn’t account for the fact that two-thirds of buybacks are done to offset employee stock ownership plans. Here’s a representative from the Fed in an email to Barron’s:

The current source for equity issuance data in the Financial Accounts of the United States does not fully incorporate issuance to employees by public corporations. Staff is exploring how best to reflect such issuance activity in future releases.

Ed Yardeni uncovered this inconsistency and I wanted to learn more. So I picked up this short book, Stock Buybacks: The True Story.
I know this topic has been covered to death so I’ll keep this brief.
The two main points in the book are that buybacks are misunderstood both by politicians who argue that it exacerbates income inequality, and the bears who argue that it is manipulating the market higher. Yardeni and co-author Joseph Abbot take a sledge-hammer to both arguments.
“Most companies don’t view buybacks as a means of returning cash to shareholders but, rather, as offsetting all or most of the dilution caused by stock compensation.” This can be seen in the data. For example, Yardeni and Abbott explain that from 2011 through 2018, large cap companies repurchased 72 billion shares and issued 50 billion shares, resulting in net repurchases of 22 billion shares.
Shares outstanding fell from a peak of 297 billion in 2011 to 275 billion at the end of 2018, an annual decline of just 1.1%.
When you talk about trillions of dollars in buybacks, jaws drop. But we must not fall prey to denominator blindness. When you look at the fact that buybacks were 0.67% of S&P 500 market cap in the second quarter, you have to ask, where’s the buyback beef?
Finally, from 2011 through 2018, the annual average spread between the total earnings and earnings per share was just 1.3%. If buybacks really were goosing EPS, you would expect the red line to have grown faster than the blue line. It hasn’t.
It’s incredible that one of the most talked about topics in all of finance has been relying on faulty data. I know this has been covered to death but I felt compelled to share this.
Click here to find all of the charts in this book.

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Two quotes I thought summed it up nicely:
“To a large extent, the bull market in stocks has been boosting buybacks, rather than the other way around as widely believed.”
“The ultimate source of funds for most stock buybacks is the employee compensation expense item on corporate income statements, not bond issuance as the bears contend.”

The Big Picture I have been reading Dr. Ed Yardeni’s research for close to 2 decades – I have always appreciated his data driven approach to thinking about markets, economics, and stock related issues. (He lives next town over; we have socialized with our wives).
Anyway, I love how he tells this story of delving into Federal Reserve Z1 Flow of Funds quarterly data. There was something about that data series that bothered him – the idea that stock buybacks alone were driving equity prices got his Spidey-sense a-tingling. It sent him down the rabbit hole of Z1.
Ed discovers that the central bank’s Z1 report was erroneously omitting the impact of stock based employee compensation, which account for as much as two-thirds of the repurchases of company stock.  He writes this up in a very small book Stock Buybacks: The True Story.
Here is the key quote from the Federal Reserve research folks in response:

“The current source for equity issuance data in the Financial Accounts of the United States does not fully incorporate issuance to employees by public corporations. Staff is exploring how best to reflect such issuance activity in future releases.”