Aggressive Stock Buybacks on the Rise: A Good Thing or Not?

Typically, companies buy back shares on the open market over a period of time, but ASRs involve contracts with investment banks, which sell a large chunk of stock upfront at a set price and more shares later over the course of up to a year.

Firms that executed share repurchases recently could prove to have been wise since many stock prices are depressed. Indeed, Bank of America noted last week that its corporate clients were heavy buyers of the recent market dip.

Both RTX and GM shares were close to multiyear lows when the companies launched their programs in late October and late November, respectively, following runs of bad news.

Buybacks make sense if companies have accumulated more cash than they pay out in regular dividends or can profitably invest, and if their shares are undervalued.

An accelerated share repurchase speeds up this process.Acompany hires an investment bank to quickly repurchase large blocks of its outstanding shares by making an upfront cash payment to the bank. A company typically approves an ASR when management believes its shares trade at a discounted valuation.

However, shareholders face a problem due to the valuation condition. Big companies tend to prioritize return of capital over return on capital, according to Ali Ragih, a senior analyst at Verity. For instance, they reduced buybacks after the pandemic stock-market crash of 2020 but increased them as shares became more expensive. However, the latest ASRs appear to be an exception to this trend.

The bigger questions for GM and RTX might be about their financial resilience, especially considering their front-loaded ASR structure. The concern is that they will not be able to backtrack if conditions change and they require cash.