Last week, Alexandria Ocasio–Cortez made several misleading statements regarding stock buybacks in Congress, as part of her push to ban such buybacks.
That being said, AOC did make a good point regarding stock buybacks that is worth analyzing.
First, though, we need to correct the statements AOC made.
AOC claims that a company’s stock repurchases push the company’s stock higher and because pharmaceutical CEO pay is “often tied to their stock price”, that the resulting bonuses paid to CEOs result in higher pharmaceutical drug prices.
That’s simply not true.
There are multiple variables that determine how any particular drug is priced for the market.
There are the actual research and development costs over many years that need to be recouped; there is the size of the market for the drug; there are the pricing arrangements negotiated with pharmacy benefit managers and insurance companies; there are the out-of-pocket costs paid by the consumer; there are the regulatory burdens that add expense to the production, manufacturing, and distribution of the medication; and there is the question of competition.
CEO pay has nothing whatsoever to do with drug pricing.
That’s because, while CEO pay and bonuses may amount to millions of dollars, those amounts are mere rounding errors when it comes to the total addressable market for a given drug.
However, AOC is right to be concerned about stock repurchases.
When a company has sufficient capital, there are three ways it can utilize that capital.
The first way is to invest that capital back into the business in order to maintain or generate growth.
The second is to pay a dividend to shareholders. Dividends are partially a reward to shareholders for taking on the risk of purchasing the company stock in the first place. These dividends are also beneficial to the economy because many elderly and retired investors will take that income and use it for consumer spending. That’s stimulative to the economy.
The third use of that capital is to repurchase company stock.
I consider stock repurchases to be the worst use of company capital with limited exceptions.
Companies like to repurchase their own stock in order to reduce the number of outstanding shares, thereby increasing each shareholder’s percentage ownership by a minuscule amount.
However, the primary reason that stock repurchases are bad for shareholders is because the companies that use them are often repurchasing their stock at prices that are above intrinsic value. That’s a bad deal for shareholders and AOC knows this.
The only time a company should be repurchasing its stock is when the stock itself is clearly undervalued. Considering the overall stock market right now is at its second-most expensive in history, most stock repurchases are a terrible use of capital right now.
What might a stock buyback ban mean for the stock market?
There’ve been $3.5 trillion of net stock repurchases over the past 8 1/2 years.
In May of this year, Ned Davis Research strategist Ed Clissold, estimated the impact that banning stock repurchases would have had on the S&P 500 since 2011.
If companies kept the money instead of using it for stock buybacks, the stock market total return would’ve been a mere 5% lower than it is today.
If the cash had instead been used to pay dividends, the total return would’ve been 10% less.
Yet the decision how a company uses its capital belongs to the company and its shareholders, not the government, and certainly not AOC.
Last modified: January 10, 2020 3:30 PM UTC