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Originally published September 7, 2022
On August 16, President Biden signed the Inflation Reduction Act (IRA) into effect. With its passage comes a new excise tax of 1% on net buybacks of company shares. The “buyback tax” aims to penalize companies for engaging in this type of shareholder action. Like so much legislation, this tax could have unintended consequences, such as: B. A wave of approvals and executions of company buybacks this year, as the excise tax only applies to the market value of net company shares bought back from 2023 onwards.
Trends in share buyback program announcements
Wall Street Horizon closely tracks buyback approvals in two flavors: initial and modified. When times are good, we tend to see more announcements of these types of corporate events. Our data shows that there was a relative lack of share buyback announcements in mid-2016, when global growth was sluggish, and then again around the Covid uncertainty in March 2020. After a strong year for equities in 2017 and the passage of the Tax Cuts and Employment Act, buyback programs and changes surged in 2018. Another spate of activity happened in the year of speculation, which was 2021. This year, however, the number of buyback events has decreased. It’s important to realize that this data is a set of events at companies around the world — it doesn’t measure the dollar value of share buyback approvals or executions.
Global buyback announcements by quarter (Q3 ongoing) (Wall Street horizon)
Buy back now before tax?
The second quarter earnings season is on the books. It’s entirely possible that unexpected buyback programs will be launched in the next few weeks by US companies looking to frontload stock buybacks before the 1% tax hits next year. We may already be seeing this – Bank of America Global Research reports that its corporate clients bought back shares at their highest price since January in the week after the law went into effect. While a 1% tax isn’t much, some argue it could open the door to higher tax rates across the board. It’s never easy to gauge the political winds, but Congressional Democrats are gaining ground in the polls and betting markets. A divided Congress could be in sight. As such, it’s unlikely that we’ll see any major changes to the tax in the next two years after the midterms.
More uncertainty: Capital allocation plans could change
Investors should watch how things develop. After all, an excise tax on company stock repurchases is essentially a tax on shareholders. That’s how former Securities and Exchange Commission Chairman Jay Clayton recently told CNBC. The C-suite understands this, and corporate leadership will change policy depending on the tax situation. Fifty-five percent of US CFOs surveyed said a hypothetical 2% excise tax on buybacks would make them reconsider how they return cash to shareholders.
Do more business?
The trickle-down effects of this piece by the IRA shouldn’t go unnoticed. If stock buybacks are more expensive, other methods of rewarding shareholders could become more popular. It’s natural to assume that dividend announcements would increase, and perhaps one-time special dividends would be more common if a long-lasting or higher buyback tax is in effect.
In addition, companies’ liquidity is building, so executives may be uneasy about how to allocate capital. Another possibility is that CFOs could get more creative with cash flow — liquidity or debt-financed M&A activity could look more attractive. Returning capital to shareholders in one form or another is not a huge preference right now, according to the August Bank of America Global Fund Manager Survey. However, this preference could change if volatility in the markets calms down.
Portfolio managers’ capital allocation preferences (August 2022) (BofA Global Research)
The industry perspective
Investors also need to know what they own. While a stock’s dividend yield is widely known and quoted, a company’s net buyback yield is less joked about. That is, the net value of shares being repurchased divided by a company’s market capitalization. According to WisdomTree, using data from FactSet, investors with significant positions in the financial and communications services sectors face the greatest risk of a buyback tax (but potentially potential upside this year before the tax is levied). Two sectors have negative net buyback yields and would be largely unaffected by the consumption tax: utilities and real estate.
S&P 500 Dividend Yield & Net Surrender Yield by Sector (as of March 31, 2022) (wisdom tree)
The final result
Wall Street Horizon’s corporate event data coverage includes a detailed count of global stock buyback initiatives and changes so investors know what’s happening with the buyback policies of the stocks they own. We also aggregate the data to identify macro trends. The new IRA legislation brings more uncertainty around shareholder attraction activities. Investors need to carefully consider portfolio risks ahead of 2023.
Original post
Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.
