The Fed’s interest rate cuts should spur plenty of buybacks by US companies

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Share buybacks — one of the defining features of the U.S. stock market over the past decade — hit a wall last year as higher borrowing costs and concerns about a potential recession prompted executives to hold on to cash.

S&P 500 companies will buy back $795 billion of their own stock in 2023, according to S&P Dow Jones Indices. That’s 14% less than in 2022, when buyout mania hit a new peak of $922 billion. It also marked the second-largest annual decline since the global financial crisis.

Redemptions are back. S&P companies spent $472 billion to buy back their own shares in the first six months of 2024, up 21 percent from the year-ago period. The Federal Reserve’s half-point interest rate cut last week will reignite a fire under that trend. Goldman Sachs expects the total to reach $925 billion this year, before breaking the $1 trillion mark in 2025.

Typically, when the Fed cuts interest rates, redemptions increase. Holding cash becomes less attractive. This time there is also the specter of an increase in the redemption tax rate from 1 to 4 percent. Companies will likely try to ramp up acquisitions before 2025.

At first glance, this should be cause for celebration for shareholders. Redemptions have been an important driver of stock performance, as stock redemptions increase earnings for each remaining share. But if that money could have been better used to maintain or grow the core business, the gains may be fleeting.

Just look at Boeing. The aerospace giant spent about $44 billion on share buybacks between 2013 and 2019, according to data from S&P Global Market Intelligence. That makes it the 15th largest buyer of its own stock during that period. However, the stock is down nearly 65% ​​from its March 2019 peak, and the company may soon need to do a mega share sale amid an endless string of safety scandals, production delays and a labor strike. workers. Critics say prioritizing buybacks instead of investing in quality and strength is what got Boeing into trouble.

Buybacks are better news when they are accompanied by investments in a company’s future. Big tech companies are among the biggest buyers of their own stock. The Magnificent 7 accounted for 26% of S&P 500 buybacks in 2023. But they’re also spending big in other areas, like artificial intelligence.

Finally, buybacks shouldn’t be the only way a company grows its earnings per share. As corporate America regains its appetite for buybacks, investors will need to take a closer look at whether EPS increases are driven by lower share counts or rising underlying profits. No one wants to end up paying more for a lower quality company.

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