On August 16, President Biden signed the Inflation Reduction Act (IRA) into law. With its passage comes a new 1% excise tax on corporate net share repurchases. “The buyback tax” aims to penalize companies for engaging in this type of shareholder accretive activity. Like so many pieces of legislation, this tax could spark unintended consequences such as a wave of corporate buyback authorizations and executions this year since the excise tax only applies to the market value of net corporate shares repurchased starting in 2023.
- The Inflation Reduction Act includes a controversial 1% excise tax on share repurchase programs that goes into effect next year
- Corporate event data shows a downtick in total buyback announcements this year after a 2021 surge
- Investors must carefully weigh risks and understand what they own ahead of 2023
Trends In Stock Buyback Program Announcements
Buyback authorizations can be tracked closely in two flavors: initial and modifications. Providers tend to see more announcements of this corporate event type during the good times. Data from Wall Street Horizon reveals that there was a relative dearth of share repurchase announcements during the middle of 2016, when global growth was sluggish, and then again in March 2020 because of COVID-19 uncertainty. Buyback program initiations and modifications rose big in 2018 following a strong year for stocks in 2017 and the passage of the Tax Cuts and Jobs Act. Another flurry of activity happened during the year of speculation that was 2021. This year, however, the count of buyback events has dropped off. It’s important to recognize that these data are a count of events among companies around the world—it does not measure the dollar value of share repurchase authorizations or executions.
Global Corporate Buyback Announcements by Quarter (Q3 Not Yet Complete)
Source: Wall Street Horizon
Buy Back Now Before the Tax?
The second quarter earnings season is in the books. It’s quite possible that the next several weeks could feature unanticipated buyback program initiations among U.S. companies seeking to pull-forward share repurchases before next year’s 1% tax hits. We already might be seeing this—Bank of America Global Research reports that its corporate clients bought back stock at the highest rate since January in the week after the bill went into effect. While a 1% tax is not much, some argue it could open the door to heftier tax rates down the line. Gauging the political winds is never easy, but the Congressional Democrats are gaining ground in the polls and betting markets. A divided Congress could be in the offing. Therefore, it is unlikely that we would see major tweaks to the tax in the next two years after the midterms.
More Uncertainty: Capital Allocation Plans Could Change
Investors should watch how things unfold. After all, an excise tax on corporate shares repurchased is essentially a tax on shareholders. That is how former Securities and Exchange Commission chairman Jay Clayton described it recently to CNBC. The C-suite understands this, and corporate executives will change policy depending on the tax situation. 55% of U.S. CFOs surveyed said a hypothetical 2% excise tax on buybacks would make them rethink how they return cash to stockholders.
The trickle-down effects from this piece of the IRA should not go unnoticed. If buying back stock is more expensive, then other methods to reward shareholders could become more popular. It’s natural to assume that dividend announcements would increase, and perhaps one-off special dividends would be more common if a long-lasting or higher buyback tax is in place.
Moreover, corporate cash is building, so executives might be antsy about how to allocate capital. Another possibility is that CFOs might get more creative with cash flow —cash- or debt-financed merger and acquisition activity may appear more attractive. According to August’s Bank of America Global Fund Manager Survey, returning capital to shareholders in one form or another is not a major preference right now. But that preference could change should volatility in the markets calm.
Portfolio Managers’ Capital Allocation Preferences (August 2022)
Source: BofA Global Research
The Sector Perspective
Investors must also know what they own. While a stock’s dividend yield is commonly known and cited, less bantered about is a company’s net buyback yield. That is, the net value of shares repurchased divided by a firm’s market cap. According to WisdomTree, using data from FactSet, investors with significant positions in the Financials and Communications Services sectors face the most risk from a buyback tax (but perhaps potential upside this year before the tax is applied). Two sectors have negative net buyback yields and would be largely unaffected by the excise tax: Utilities and Real Estate.
S&P 500 Dividend Yield & Net Buyback Yield by Sector (As of March 31, 2022)
Source: WisdomTree, FactSet
The Bottom Line
Corporate event data coverage that includes a detailed count of global share repurchase initiations and modifications allows investors to know what’s happening with buyback policies of the stocks they own. When the data is aggregated, investors can also spot macro trends. The new IRA legislation brings about more uncertainty regarding shareholder accretive activities. Investors must carefully weigh portfolio risks ahead of 2023.
This article was originally published on the Wall Street Horizon website.
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