Recently, there has been a trend among both Canadian and United States companies to buy back their shares in order to boost stock prices. In the past – most notably during the “Buyback Bonanza” of 2007 – this strategy has been employed by companies as a mechanism to decrease the amount of outstanding shares, thereby increasing the value of the stock.
For years some have criticized share buybacks, asserting that focusing on short term increases in stock prices and profits is detrimental to long term economic growth. They argue that as individuals invest more in the short term, there is less investment to be made in capital improvements such as factories and technology. In their view, this has two negative implications: less investment translates to decreased earnings in the long-term and decreased future growth.
Others argue that short-termism is not a problem or, to the extent it is, is not as harmful to the economy as once believed. Statistics demonstrate that business investment in the U.S. has remained stable between 11-15% of GDP since 1970. Further, many argue that it is in fact economically efficient for executives to invest in their own companies provided that they perceive it to be the most appealing investment opportunity at the time, because companies in turn distribute this capital back to their shareholders who will then reinvest into the market.
However, in many cases, diminishing returns have caused investors and analysts to wonder whether buying back shares is an effective, long-term strategy. While the strategy may be rewarding for companies that demonstrate high sales and earnings growth independently of this tactic, other companies have not been able to reap the rewards of high share prices, despite large sums being spent on buybacks. As a result, analysts have suggested that perhaps that money would be better spent on capital improvements, such as better technology.
In spite of these concerns, we are seeing a strong resurgence in buyback activity in both the US and Canada. In the US, rates are expected to exceed those seen in 2007, where share purchases among S&P 500 companies hit a record number of $589.1 billion. The S&P 500 Buyback Index, which tracks the performance of the top 100 stock repurchasers, has gained only 1.3% this year, which is well under the performance for S&P 500 companies.
In Canada, while data are not as readily available, the trend is especially noticeable in the oil and gas sector, given the relatively low current stock prices in this industry. As the Financial Post has reported, a “disconnect” between depressed equity prices coupled with rising oil prices are spurring significant buyback activity among numerous Canadian oil and gas companies, particularly in Calgary-based companies. Further, the persistent downturn in the industry has motivated companies to reduce operating costs, which has in turn generated free cash to support buyback activity.
The trend is not limited to the oil and gas sector, either: in 2017 and 2018, prominent issuers in other industries also announced a share repurchase program (instance, in the financial services sector, as the Financial Post has also reported).
While both Canada and the United States seem to be following a similar path on this trend, it is important to reflect on whether the difference in Canadian issuer bid rules and the American voluntary safe harbour provision for stock repurchases – namely, Rule 10b-18 – might impact future activity. Both jurisdictions have implemented limitations on the percentage of share repurchases in a given period of time; however, the limitations of the U.S. are less stringent in that the restriction is on a daily basis. This means that while an issuer’s purchase cannot exceed 25% of the average daily volume, this cap resets the following day. The rules on normal course issuer bids in Canada on the other hand, only allow an issuer to repurchase either 5% of the outstanding shares or 10% of the Public Float, whichever is greater. So far, these differences do not seem to be having a major impact as both countries are seeing the stock buyback trend, but it is worth paying attention to in the coming months.
Overall, the strategy can be a risky one. Indeed, the “Buyback Bonanza” in 2007 was just before the stock market underwent its worst state since the Great Depression. This means that companies should be cautious in resorting to this strategy and consider the (possibly detrimental) consequences. Companies considering buying back shares in the face of distressed balance sheets or minimal free cash should be especially wary of potentially adverse outcomes.
The authors would like to thank Saba Samanianpour and Jessica Silverman, articling students, for their assistance in preparing this post.