Senate Legislation Proposing Rules for Share Buybacks Would Weigh on Market Fundaments, Goldman Says

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Legislation that’s been introduced in the US Senate to prohibit public companies from repurchasing their shares on the open market would force firms to change their cash-spending priorities and impact the fundamentals of the equities market, Goldman Sachs said.

A restriction on buybacks would slow growth in earnings per share, increase cash spending on dividends, mergers and acquisitions and debt reduction, widen trading ranges, reduce demand for shares and lower company valuations, analysts including David Kostin and Ben Snider said in a note.

“S&P 500 firms allocated an average of 25% of their annual cash spending to buybacks since 2009,” they said. “Eliminating repurchases would compel firms to find new uses for that cash.”

In a February op-ed in the New York Times, Senators Chuck Schumer, a Democrat, and Independent Bernie Sanders said companies are focused on shareholder value rather than investing in “ways to make their businesses more resilient or their workers more productive.”

Stock buybacks boost the value of the shares by lowering the number of those left publicly traded “to the benefit of shareholders and corporate leadership,” the lawmakers said. Their proposed legislation would “would set minimum requirements for corporate investment in workers and the long-term strength of the company as a precondition for a corporation entering into a share buyback plan.”

Repurchases surged to record levels in the wake of corporate tax reform that freed up funds to be spent on buybacks. In the fourth quarter of 2018, S&P 500 companies’ buybacks jumped 56% year-on-year to a record $806.4 billion, and dividends rose 8.7% to $456.3 billion, Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, said in a note last month.

Removing or limiting buybacks would “lead to a greater amplitude of index moves, a wider distribution of individual stock returns, and higher volatility,” Goldman Sachs said. “Prohibiting buybacks would reduce downside support for equity prices since companies could no longer step in to repurchase shares if their stock prices tumble.”

If earnings per share growth is reduced — because there’s more shares outstanding — that could lead to price-to-earnings multiple contractions, lowering valuations.

“In a world without buybacks, forward EPS growth could be trimming by 250 (basis points), close to the impact of net buybacks on company-level EPS growth,” the Goldman analysts said. “Prohibiting buybacks could also apply downward pressure to equity prices if it increases the supply of equities relative to demand at current prices.”

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