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The practice of a corporation buying its own shares has been a contentious one for the best part of a decade.

Some have argued it is merely a more tax-efficient way than dividends for corporations to return cash to shareholders. Others posit that it is tantamount to market manipulation, as it helps management hit compensation targets related to earnings-per-share numbers by shrinking the denominator.

What there’s little argument about, however, is the scale of transactions signed off by chief financial officers across corporate America over the past 10 years. The figure runs into the trillions of dollars.

Want a hard number? Well the accounting wizards at Zion Research have, in American parlance, “done the math”, and have found $3.9tn was spent on buybacks by the constituents of the S&P 500, excluding financials, since early 2010.

But despite the sturm and drang over bailing out the various industries affected by the coronavirus -- in particular, airlines, who loved a buyback -- what really should be under scrutiny is not the scale of these stock repurchases, but how they were financed. 

Out of free cash flow? Then fine. That’s a capital allocation decision. But buying back shares by taking on more debt? Well, questions should then be asked. After all, that’s a gamble that the business remains solvent enough to service these debts in the future, even after the cash has been dispensed to shareholders.

In aggregate across the S&P 500 (ex-financials), according to Zion Research, only 52 per cent of free cash flow was spent on buybacks. However, 67 companies spent more than all the free cash they generated on stock repurchases, and 27 of those had negative free cash flow over the decade.

27. That’s more than 5 per cent of the entire index:

Although the US Treasury is already rolling out programmes to help out ailing companies, may we suggest that the terms for those offenders are a touch more usurious than the companies who spent within their means? Perhaps a higher interest rate on the loan, or warrants that are automatically in-the-money when granted.

While the moral hazard argument, in our opinion, doesn’t hold much weight during this period, as the problem is exogenous, aggressive terms for those who on took on more balance sheet risk would at least send a signal to companies expecting a Treasury backstop in the future.

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