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Hey, companies, it's time to buy back some stock

By BRUCE MEYERSON
Published May 24, 2006

Even though Congress extended President Bush's tax break on stock dividends, a good case can be made that companies should pay little mind and focus instead on buying back even more of their stock.

There's so much extra cash sloshing around that the nation's biggest companies are setting records of a dubious sort: Last year, interest income rose 38 percent to $15.7-billion after taxes among the 375 nonfinancial companies in the Standard & Poor's 500, a new S&P study shows. That total is expected to soar 70 percent this year to $26.7-billion.

That represented a meager return of 3 or 4 percent on the liquid assets at those companies, which rose from $594-billion when 2005 began to $633-billion at year's end.

Building a war chest can make sense, particularly at companies that see legitimate growth opportunities ahead. But the risk of the money being squandered is ever-present.

"What you're worried about is that the company does something dumb with it," said Matthew Rhodes-Kropf, a professor of finance at Columbia University. With checks in place, such as an engaged board of directors or a large active shareholder, the CEO "tends to wait for a darn good project. If not, you make a smokeless cigarette," he said.

Absent promising ventures, the logical answer is for companies to distribute more cash to shareholders. And though it contradicts the popular preference for dividends, many researchers and investment analysts consider buybacks a better way to return capital to stockholders.

This can be hard to conceptualize, since it sounds more equitable to distribute cash to all shareholders at regular intervals through dividends. But share buybacks are as much a means of returning wealth to stockholders as a quarterly dividend, and in some ways superior.

The reason mostly boils down to taxes. As long as the tax rate for dividends and long-term capital gains from a stock sale remains equal at 15 percent for most investors - a situation assured through 2010 - buybacks afford each shareholder the flexibility to decide when and how much taxable income to withdraw from an investment.

Dividends are automatically taxable and cannot be offset with investment losses. With buybacks, those who decide to sell some shares may have a higher price than those who don't sell, and therefore face less of a tax burden. Alternately, sellers may have a loss on another investment to offset the taxable gain.

Rhodes-Kropf said those who prefer the steady income stream of a quarterly payout can simply sell the equivalent portion of their stock at regular intervals, though such an approach would entail some transaction costs.

There are caveats to buybacks to keep in mind, particularly with technology companies and others that rely heavily on stock options to pay employees. In such cases, buybacks may accomplish little more than to offset new shares issued when employees exercise options.

Alternately, if they succeed in reducing a company's public shares, buybacks can muddy earnings comparisons from year to year. Exxon Mobil Corp., for example, repurchased $6-billion worth of stock during the first quarter, including about $1-billion worth to offset dilution from options. As a result, earnings per share rose 12.3 percent compared with the first quarter of 2005, while net income of $8.4-billion rose just 6.9 percent from year-ago levels.

This potential confusion has spread more broadly since late 2004. The share count among the S&P 500 has fallen for six consecutive quarters, the first such streak in at least three decades.

Dividends, of course, are so etched into the mentality of the market that they're not going away. For starters, they're seen as a way of communicating confidence. Knowing they'd get hammered if they cut their dividend, most companies wouldn't start or boost a quarterly payout unless they're fairly certain they won't have to reduce or eliminate it.

Buybacks suggest a degree of optimism that management thinks its stock is a good deal. But the message can be weaker because companies often offer no guarantee or timetable for the planned buybacks.

It's not as if companies haven't been shoveling cash back to shareholders. Stock buybacks among the S&P nonfinancials grew 77 percent to $349-billion in 2005, while dividends rose about 12 percent to $202-billion.

Nevertheless, there's too much cash building up on the sidelines earning too little interest. Whether it's buybacks or dividends, more of that money should be returned to shareholders.

Bruce Meyerson is a national business columnist for the Associated Press. Write to him at bmeyerson@ap.org.

[Last modified May 24, 2006, 05:52:08]