Karp added that buybacks and dividends aren’t a big issue if they’re funded by private capital, though she considers buybacks to be a form of financial engineering.
Dividends are another matter. “If we have an investor who needs dividends to generate cash, we can do a dividend strategy,” Karp said. “You can do sustainable and impact investing with a dividend strategy. There’s no inconsistency at all with that.”
Buyback Bogeyman
For now, both buybacks and dividends are verboten for companies participating in the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which includes a $500 billion package of loans, loan guarantees and other investments designed to aid certain businesses affected by the pandemic.
Public companies that borrow money under the CARES Act can’t buy back company stock (unless they had a pre-existing contract to repurchase shares) or issue dividends for one year after the loan repayment or expiration of the loan guarantee.
Buybacks have become a bogeyman of sorts. Critics contend they are an accounting gimmick that artificially boosts a company's per share earnings and, consequently, its stock price. They also say buybacks divert money that should be reinvested into the company or that they deplete cash reserves that could provide a cushion during an economic downturn.
These are valid points. But another valid point is that corporate buybacks have evidently been the prime support pillar for U.S. equities during the past decade or so.
Brian Reynolds, chief market strategist at research firm Reynolds Strategy, said in a Wall Street Journal article last month that corporate buybacks have been the only net source of money entering the stock market since the financial crisis in 2008. He noted that contributions from all other sources—ranging from exchange-traded funds and mutual funds to foreign buyers and households—netted out to roughly zero.
Bob Shea, CEO of TrimTabs Asset Management, said he has charts that draw a similar conclusion. He noted that bonds have been the asset class attracting the most money since the great financial crisis, and that there were net outflows in U.S. equities last year even as the S&P 500 gained roughly 30%.
“There were some inflows to equities in April, but there were more inflows to bonds and commodities than equities last month,” Shea said. “To be able to sustain current valuations, we’ll need some new sponsorship of equities [if corporate buybacks are curtailed].”
TrimTabs has two ETFs that focus on free cash flow, and the current cash flow crunch has been a big story line during the pandemic-fueled economic catastrophe. Shea said it remains to be seen how this will impact shareholder distributions.
“I don’t think they’re equal; I think the stigma of buybacks is worse than dividends,” he said. “Dividends will be judged a little more kindly, but it will be on a situational basis. With dividends, it depends on the financial condition of the company and whether they’re taking government money.”