For the past 20 years, IBM has been an avid, methodical buyer of its own stock. In 1993, it had 2.3 billion shares outstanding. Today it has 1.1 billion, shrinking at more than 1% per quarter over the past few years. At that pace, there will be no more publicly traded IBM shares left by 2034.
Rejoice! You might regard all this buying as good news for shareholders. Buybacks push up earnings per share. They flaunt management’s confidence in the future. And they are a reason why retail investors have held on so lovingly to IBM stock.
Look deeper at IBM and dozens of mature U.S. companies, and you can sketch a different, more ominous, story: That CEOs are in fact stuck, reluctant to build new plants, launch products or pursue an acquisition.
By rote and by fear, they are pitching their billions into buybacks, nearly $1 trillion from the 100 largest companies in the S&P since 2008. In the 12 months ending in September, the total dollar amount of all corporate buybacks increased by 15% from a year earlier, according to S&P Dow Jones Indices.
Cheap money from the U.S. Federal Reserve helps sweeten this deal. And one can’t underestimate the threat from shareholder activists, who now patrol the market like prison guards with billy clubs. Overspend and get whacked.
Other investment just hasn’t materialized at the same rate. Among the entire S&P 500, the median change in capital spending is 16.7% over the past five years, based on a screen of stocks using Capital IQ data.
The danger is that those buybacks have been substituting for substantive future investment, be it software engineers, new products, or extra marketing.
This has two effects: It stymies the economic growth originally intended by the Fed. And it could eventually leave businesses ill-equipped to adapt to changes in their industries, especially technology-intensive ones. Hewlett-Packard Co. pumped tens of billions into (high-price) buybacks from 2003 to 2011 and is now is struggling to find its way.
IBM competitor Amazon.com Inc., meanwhile, continues to pour in big dollars into actual technology. It grew its capital spending 14-fold since 2008, and R&D spending fivefold.
Investor Jim Chanos is starting to worry about just this problem. As one of Wall Street’s best-known short sellers, he’s quietly been building an investment thesis around the idea that buybacks are a sign of corporate weakness, not strength.
Mr. Chanos shared his analysis with me from a bright conference room in his Midtown Manhattan office. We were both left agog at what the numbers seem to show about how companies are allocating their dollars. Can this really be right?
By his count, for instance, the recent return on IBM’s buybacks is about 6.5%. Not a terrible number. But IBM’s return on what he dubs its “net business assets”—actual stuff used in actual business—is far better. It is 18.1%.
Maybe IBM has concluded there is no better place to put its money. Or that it is simply doing what stockholders want. It is hard to tell.
“Our capital allocation model drives reinvestment in the business through R&D, capital expenditures, and acquisitions, it pays the dividend every quarter since 1916, and it returns excess capital to shareholders through share repurchase,” said IBM spokesman Michael Fay. “We can do both, invest and return cash, and we do.”
IBM is no outlier. Honeywell International Inc. has been earning about 3.8% on its buybacks, according to Mr. Chanos’s numbers, compared with 13.4% on business assets. Honeywell spokesman Robert Ferris said the company’s total return—which combines share-price appreciation and dividends—had outpaced its peers and the broader S&P 500 over the past decade. During that stretch, Honeywell has split cash flows roughly in two—between business investment and returns to shareholders, Mr. Ferris said.
Oracle Corp.’s numbers also showed a large split, between 4.8% return on buybacks and 32.1% on assets. Oracle declined to comment.
“Corporate CEOs, with their massive share-buyback programs are in effect investing in the stock market rather than in expanding business opportunities at their companies,” said Mr. Chanos. “Either they expect higher returns from the market, or lower returns in their business, or some combination of both. Given their questionable track record in timing the market, this may be a cause for concern.”
Mr. Chanos said he was shorting stocks based on this thesis. He wouldn’t specify which ones.
As for IBM, buybacks still rule. It has raised the amount in recent years and since 2007 has spent $60.4 billion. The company just made announcements about new investments in data centers and its Watson analytics product. But annual capital spending and research and development have been roughly flat for nearly a decade, between $10 billion and $11 billion.
Many on Wall Street are now beginning to regard IBM as a company more focused on its stock price than its long-term path. “Only IBM knows what it might be forgoing,” says Barclaysanalyst Ben Reitzes. But “one can make an argument for organic investments,” especially with revenues shrinking 3% and fresh competition from cloud-computing competitors.
This question of investment isn’t a conundrum just for IBM. It is for every CEO protective of his job, unsure about the economy, and fearful of the activists with the prison-guard eyes.
And so here it is in 2014, five years since the worst of the financial crisis. Are they playing to win? Or still playing not to lose?
An earlier version of this article misspelled Ben Reitzes’s last name as Rietzes.