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Share Buyback Tax

Share Buyback Tax

A new 1% share buyback tax was signed into law by President Biden this past week as part of the Inflation Reduction Act. Share buybacks are not taxed today. Hence, the US Treasury will significantly benefit because of the increase in revenue. Moreover, the tax will be paid by corporations and not investors. In 2021, companies repurchased a record $881.7 billion of their stock. Consequently, the US Treasury stands to gain about $9 billion per year, not a tiny sum but not a large sum either in the context of the total federal budget and deficit. The new tax takes effect on January 1, 2023.

Share Buyback Tax
New Share Buyback Tax

What is a Share Buyback?

A share buyback is when a company purchases its own stock in the open market with excess cash. The activity is also referred to as stock repurchases. Companies can use their cash flow to reinvest in the company, i.e., capital expenditures, pay down debt, pay a regular dividend, pay a special dividend, repurchase shares, or acquire another company.

Corporations conduct share buybacks to reduce dilution from stock options, because management feels the stock is trading at a low valuation, or they cannot find a better use for the excess cash.

The net effect is to lower the share count and increase the earnings per share because of a lower share count. In addition, this change affects the price-to-earnings ratio because the share price is the same, but the EPS is higher. Also, less cash on the balance sheet improves the return on assets (ROA) and return on equity (ROE) metrics.

Which Companies Will Be Affected by the New Share Buyback Tax?

In 2021, companies repurchased a record of about $881.7 billion of their own stock. This amount was 69.6% higher than 2020 and 9.3% more than 2018, the last record. 

Apple (AAPL) was the leader with about 10% of the total value, followed by Meta (FB), Alphabet (GOOGL), Bank of America (BAC), and Microsoft (MSFT). Combined, the top 20 companies repurchased about $428.8 billion in stock. Moreover, the Information Technology sector is the far-away leader in share buybacks by dollar value.

The tables below show S&P 500 share buybacks by sector and the top 20 companies.

SP500 Share Buybacks by Sector
Source: S&P Dow Jones Indices
SP500 Share Buybacks by Top 20
Source: S&P Dow Jones Indices

Which are Better, Share Buybacks or Dividends?

Some investors tend to like share buybacks over dividends and vice versa. The new share buyback tax will probably affect how companies return cash to shareholders. One study by the Tax Policy Center estimates that the new 1% tax will result in a 1.5% increase in dividend payouts, presumably because companies don’t want to pay the tax.

Personally, I like dividends over share buybacks because I am a dividend growth investor. For dividends, I choose what to do with cash rather than the company. Furthermore, dividends matter because they are usually a major fraction of total returns.

On the other hand, some shareholders like stock buybacks because some evidence suggests it boosts returns after the announcement. However, other studies show no long-term effect on returns. Also, some investors don’t like paying taxes on dividends, and share buybacks avoid that issue unless the investor sells shares to the company and triggers a capital gains tax.

However, dividends are not as volatile as share buybacks. A dividend cut or omission dramatically affects a company’s stock price. Hence, corporations will reduce share buybacks in favor of dividends making the dollar value fluctuate annually. Furthermore, some companies often buy back stock when the price is too high and not when it is undervalued. One does not have to look too far for anecdotal evidence of this behavior.

Final Thoughts on the New Share Buyback Tax

The new 1% share buyback tax will affect how companies behave. However, the current tax is low, so that the effect may be small. In any case, if dividends increase at the expense of share buybacks, most dividend growth investors, like Ronald Read, will be happy as the save for a future retirement.


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The Stock of the Week

Today we highlight Verizon (VZ), the communications giant. According to Stock Rover*, the stock price was down nearly 11.3% year-to-date and approximately 16% in the past 1-year. Verizon is struggling with slow growth in its core cellular service and competition. Additionally, broadband service is expensive to expand beyond metro areas. Verizon competes directly with AT&T (T) and T-Mobile (TMUS) for cellular service with a combined 90%+ market share.

The dividend yield is a whopping ~5.76%, the highest in the past decade and well over the 5-year average of about 4.47%. Next, Verizon is a Dividend Contender and, according to Dividend Radar, has 18 years of dividend increases. Investors should not expect much growth from Verizon, but the dividend yield is outstanding, and the payout is relatively safe. The stock is a decent one for income and undervalued based on past metrics.

Verizon Valuation
Source: Stock Rover*

Dividend Increases and Reinstatements

Search for a stock in the list of dividend increases and reinstatements. This list is updated weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

The dividend cuts and suspensions list was most recently updated at the end of July 2022. As a result, the number of companies on the list has risen to 563. Thus, well over 10% of companies that pay dividends have cut or suspended them since the start of the COVID-19 pandemic. The list is updated monthly.

Three new additions indicate companies are experiencing solid profits and cash flow in July.

The new additions were Rio Tinto (RIO), Industrial Logistics Properties (ILPT), and Franklin Street Properties (FSP).

Market Indices

08/20/22

Dow Jones Industrial Averages (DJIA): 33,706 (-0.16%)

NASDAQ: 12,705 (-2.62%)

S&P 500: 4,228 (-1.21%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 21.37X, and the Schiller P/E Ratio is about 31.68X. These multiples are based on trailing twelve months (TTM) earnings.

Note that the long-term means of these two ratios are approximately 16X and 17X, respectively. 

The market is still overvalued despite the recent market correction and a bear market. Earnings multiples more than 30X are overvalued based on historical data.

S&P 500 PE Ratio History

SP500 PE Ratio
Source: multpl.com

Shiller PE Ratio History

Shiller PE Ratio
Source: multpl.com

Stock Market Volatility – CBOE VIX

This past week, the CBOE VIX measuring volatility was down about 0.50 points to 20.60. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 Index options. It is commonly referred to as the fear index.

CBOE VIX
Source: Google

Yield Curve

The two yield curves shown here are the 10-year US Treasury Bond minus the 3-month US Treasury Bill from the NY York Fed and the 10-year US Treasury Bond minus the 2-year US Treasury Bond from the St. Louis Fed.

Inversion of the yield curve has been increasingly viewed as a leading indicator of recessions about two to six quarters ahead, according to the NY Fed. The higher the spread between the two interest rates, the higher the probability of a recession.

10-Year Bond minus 3-Month Bill
Source: NY Fed
Spread Between 2-Year and 10-year US Treasuries
Source: St. Louis Fed

Economic News

The US Census Bureau reported housing starts dropped 9.6% to a seasonally adjusted annual rate of 1.446M units in July, the lowest level since February 2021. The data for June was revised up to 1.599M units from the previously reported 1.559M units. Single-family housing starts, which account for the majority share of homebuilding, fell 10.1% to a rate of 916K units, the lowest level since June 2020. Starts for housing projects with five units or more also dropped, declining 10% to a rate of 514K units. Building permits saw increases in the Northeast (+9.3%) and Midwest (+8.1%), while the West (-12.0%) and South (-0.1%) saw declines.

The Commerce Department reported advance US retail and food services sales were little changed at $682.8B in July, and this follows a downwardly revised 0.8% gain in June. Retail sales are up 10.3% year over year. Total sales for May 2022 through July 2022 were up 9.2% year over year. A drop in sales at service stations (-1.8%) and at auto dealerships (-1.6%.) couldn’t offset increases coming from internet (+2.7%), miscellaneous retailers (+1.5%), building supplies (+1.5%), electronics (+.0.4%), and home furnishings (+0.2%). In addition, sales declined in department stores (-0.5%) and clothing stores (-0.6%).

The National Association of Realtors reported that existing home sales fell 5.9% in July to a seasonally-adjusted annual rate of 4.81M, down 20.2% compared to July 2021, and a new low since May of 2020. Home sales have now dropped for six consecutive months. Total housing inventory was reported at 1.31M, up 4.8% from June’s inventory (unchanged Y/Y). Unsold inventory is at a 3.3-month supply, up from 2.9 months in June and 2.6 months in July 2021. Properties typically remained on the market for 14 days in July, the same as in June and down from 17 days in July 2021. The median sales price of an existing home sold in July dropped to $403,800 (+10.8%Y/Y), down from the record $413,800 set in June. The median existing single-family home price was $410,600 in July (+10.6% Y/Y), while the median existing condo price was $245,900 (+9.9% Y/Y). Existing-home sales declined in all regions, led by the West (-9.4%), followed by the Northeast (-7.5%), South (-5.2%), and Midwest (-3.3%).

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2 thoughts on “New Share Buyback Tax – Week in Review

  1. Mike Santoli/CNBC “leaked” (while laughing)that the buyback tax is on NET stock repurchases, the tech industry lobbied hard to get that in the bill, he said they issue more stock options than buybacks !

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