Stock Buybacks!™ and the Monetization of Stock-Based Compensation


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Here’s your capital back, Mr. Shareholder, returned to you in a tax-advantaged way!”


I love stock buybacks.

I mean, there are only five things that profitable companies can do with their cash:

  1. they can expand their existing operations by building new facilities, funding new projects and hiring new people,
  2. they can pay down any debt they might have,
  3. they can give the cash back to shareholders directly as a dividend,
  4. they can acquire another company, or
  5. they can ‘acquire’ their own company by buying back shares.

When I was running my hedge fund back in the day, I loved it when the management team of a company with good organic earnings growth would buy back shares and shrink the share count. Depending on the cost of capital and the degree to which a buyback would magnify that earnings growth per share, I was even fine with management borrowing money to do a buyback.

In my experience, cash burns a hole in most management teams’ pockets. Their natural instinct is to spend the cash – and it is MY cash as a shareholder, not their cash – on an empire-building acquisition or internal expansion, and if they’re not going to give me MY money back directly in the form of a dividend (on which I have to pay taxes, so ugh, but okay), then the least harm they can do is buy back shares and shrink the share count.

AND SHRINK THE SHARE COUNT.

See, the flip side of my love for management teams that used stock buybacks to shrink the share count and give me a greater fractional share of a growing organic cash flow was my hate for management teams that diluted my fractional share of a growing organic cash flow by awarding themselves absurd amounts of stock. Worst of all were the management teams that announced a stock buyback program with great fanfare that only offset the stock they had already awarded themselves!

This circular process of issuing new shares to employees and then buying those shares back with company money – MY money as a shareholder – is called ‘sterilization’.

Sterilization has been around forever, and to a limited degree it’s fine. Yes, management teams and employees should get some reasonable level of stock-based compensation. Yes, it may make sense to use some of my cash to sterilize those shares and keep the share count from expanding. But don’t tell me that the sterilization of newly issued shares is anything other than a direct compensation expense that I am paying for with MY money. Don’t tell me that the sterilization of newly issued shares is somehow a “return” of cash to ME, because it’s just not. The sterilization of newly issued shares is a direct transfer of my money to YOU, the recipient of those newly issued shares. Nothing more, nothing less.

I believe that there has been a sea change in markets over the past ten years in the size and scope of these sterilizing stock buybacks.

I believe that there has been a truly astronomical transfer of wealth – well more than a trillion dollars – over the past ten years from shareholders of publicly traded companies to managers of publicly traded companies. Not founders, not entrepreneurs, not risk-takers … managers.

I believe that this sea change has been driven by the intentional trumpeting of three narratives by management teams, boards of directors and their rah-rah Wall Street/CNBC accomplices:

  • “Our Interests Are Aligned” to justify larger and larger amounts of stock-based comp,
  • “Non-GAAP is the Best Way to Understand This Company’s Fundamentals” to justify downplaying stock-based comp and share dilution as a crucial issue for investors, and
  • “We’re Returning Cash to Shareholders” to justify the sterilization of that stock-based comp with stock buybacks.

Here’s how it works:


Step 1: Boards and management teams award themselves and mid-level to senior executives large amounts of stock-based comp to “align our interests with shareholders” and “retain talent”.

Step 2: Wall Street/CNBC analysts treat that stock-based comp as a non-cash, safely ignored item in their “non-GAAP” estimates that drive the narrative around company performance and shareholder expectations.

Step 3: Boards and management teams use stock buybacks to monetize stock-based comp with shareholder cash.

Step 4: Wall Street/CNBC analysts trumpet the sterilizing stock buyback as “returning cash to shareholders”, encouraging shareholders to not only ignore the transfer of their money to management, but to embrace it.


Wash, rinse, repeat.

This is what transforms stock buybacks, a perfectly reasonable and often investor-friendly use of cash, into Stock Buybacks!™, a perverse system of self-dealing and never investor-friendly use of cash.

I love stock buybacks, but I despise Stock Buybacks!™.

I’m going to show you two examples of investor-wrecking Stock Buybacks!™ and one example of investor-enriching stock buybacks.

The villains in this story are Meta and Google, two companies whose major purpose in this world is apparently to create thousands of mid-level executive millionaires at the expense of shareholders. These two companies alone have transferred more than $300 billion from shareholders to employees in their monetization of stock-based comp over the past ten years.

The hero in this story is Apple, the most prolific user of stock buybacks in the world (more than half a trillion dollars!), but a company that actually returns capital to shareholders with its buybacks rather than sterilizing outrageous stock-based comp.

Okay, we’ll start with just the basic facts about stock buybacks and share counts for these three companies over the past ten years. All of this information is taken straight from the companies’ SEC filings and is current through 9/30 of this year (that’s ten full years of data for Apple, which has a 9/30 fiscal year, and nine full years plus the first three quarters of 2022 for Meta and Google, which have a 12/31 FY).



All of the entries marked with a $ sign are in millions of dollars, so, for example, Meta has bought back $95.8 billion worth of its stock over the past ten years. The share count data is in millions of shares, so, for example, Google has issued 1.7 billion new shares to employees over the past ten years, diluting its starting share count by 12.8%. Google has also bought back 1.9 billion shares with its $156 billion worth of buybacks, but because of the newly issued shares that only shrank the original share count by 1.2%.

[A quick aside on the timing of stock issuance and stock buybacks. For all three of these companies, the level of new stock issuance to employees has been pretty constant over the past decade. There has not been an acceleration in the dilution to shareholders over this period, which is to the credit of all three companies. In fact, the largest dilution for employee stock at Meta – about 1/3 of the total – took place in 2013-2014, so if you want to back this out the numbers for Meta look better (please note, though, that I have backed out new shares issued for corporate and acquisition purposes so that they are not included in the totals above). What isn’t constant, though, is the use of stock buybacks. Among the three, Apple began buying back stock first (2013), followed by Google (2015), followed by Meta (2017), and the numbers have grown significantly over time. For example, the total amount spent on stock buybacks in 2021 was ~$180 billion across the three companies, more than 4x the ~$41 billion they spent on stock buybacks in 2017. As a result, Meta and Google can truthfully say that they have, in fact, been shrinking their share count through stock buybacks in recent years (2021-2022 for Meta, 2019-2022 for Google), but this ignores the prior years of share count expansion. Now that Google has successfully sterilized its employee issuance over the past decade and essentially returned to its 2012 end-of-year share count, it will be very interesting to see if the company continues with the same level of share count-reducing stock buybacks in 2023 or scales them back. End of aside.]

The ratio of new shares issued to employees divided by the shares bought back by the company is the buyback sterilization percentage. This is the percentage of stock buyback dollars that went to sterilize the dilutive new shares owned by employees. It can’t be greater than 100%, which happens when – as you see with Meta – the stock buybacks don’t fully sterilize the newly issued shares. I’m highlighting the buyback sterilization percentage because you multiply that percentage by the actual stock buyback dollars to figure out how much cash went to monetize the stock-based comp. That’s the first line in the chart below, and that’s my starting point to to figure out how much of MY money as a shareholder is being spent on this monetization.



But wait, there’s more! In addition to the cash used to sterilize the new issuance of stock-based comp, most publicly traded companies today also use shareholder cash to pay for the taxes that employees owe on the stock-based comp. This is part of the magic of Restricted Stock Units (RSUs) that have almost completely replaced the old mechanism of awarding stock-based comp, which was options issuance that the employee could exercise by paying some low price to the company. With RSUs there is (typically) no cash impact on the employee receiving the stock-based comp at all, and (typically) no tax consequences, either.

The way this works is that the company will award, say, 10,000 RSUs to an employee, vesting (i.e., converted into actual stock and given to the employee) at the end of the year for accomplishing certain goals of the job. The value of those 10,000 shares (no longer RSUs, but newly issued shares) is considerable for the employee, and he or she will owe taxes on that. Moreover, since this is ordinary compensation, the company is required to withhold taxes on this and send it to the IRS. So the company takes back, say, 30% of the shares it just handed out in order to satisfy that tax withholding obligation. And since the company doesn’t want to sell those shares on the open market, it pays the IRS cash for the current value of those withheld shares. In the case of Google, for example, $48 billion of shareholder money has been spent over the past ten years paying for its employees’ taxes on RSU awards. This is exactly the same thing as the company buying back shares in the open market, except that they’re not buying back shares in the open market but are buying back shares directly from employees.

Put these cash tax payments together with the sterilized percentage of the cash stock buybacks and you have the total cash cost of monetizing stock-based comp (there’s a small off-setting amount in options exercise cash that Meta employees paid the company). Now I want to compare that total monetization cost of stock-based comp to the free cash flow (FCF) and cash flow from operations (CFO) that these companies have generated over the past ten years (every company calculates FCF and CFO a little differently; this data is taken straight from how the companies report it to Bloomberg).

I’m making this comparison because free cash flow (and to a lesser extent cash flow from operations) IS the money generated by a company that belongs to me as a shareholder. It’s the cash that’s left over after the company has spent whatever it must spend, and deciding how to spend this cash is among the top two or three strategic decisions that a board of directors and senior management team must make.

I am trying to think of the right word to describe a board and senior management team that would deliberately choose to spend 77% or 63% of a company’s free cash flow over a decade to monetize the stock-based comp awarded to that company’s employees, above and beyond the billions and billions in cash compensation paid to those employees.

I am trying to think of the right word to describe a board and senior management team that would deliberately characterize the lion’s share of that free cash flow spend – the sterilization of newly issued shares – as a “return of capital to shareholders”.

The best word I have is the same best word that Tennessee Williams had.

Mendacity

Three hundred billion dollars worth of pure mendacity on the part of Meta and Google’s boards and senior management teams over the past decade. Hundreds of billions of dollars worth of still more mendacity from all the other boards and senior management teams of publicly traded companies that have joined hands with Wall Street to do the same Stock Buybacks!™ dance to monetize their stock-based compensation.

Oh, I know what the response will be, both from these companies and the Stockholm-syndrome investors who will defend them.

You’re conflating management with rank-and-file employees, and this level of stock-based comp is necessary to retain our amazing employees here at Meta/Google. Otherwise, they would leave us for Google/Meta.

You’re just another mindless critic of stock buybacks who clearly doesn’t understand basic math or accounting principles. Stock-based compensation is reported in our quarterly income statements, stock buybacks are simply a tax-advantaged way of returning capital to shareholders, and you must be a socialist Bernie Bro to suggest otherwise.

Management’s interests can only be aligned with shareholder interests through stock-based awards, and the superb stock market performance of Meta/Google shows that shareholders have benefitted enormously from the wise decisions of this board and senior management.

Oh wait, I guess maybe I won’t be hearing that third argument so much these days.

My response is simple. First, bah! Second, it doesn’t have to be this way, and I can prove it.



In addition to using 88% of its stock buybacks in a non-sterilizing, actual share count reducing manner that does in fact return capital to shareholders in a tax-advantaged way, Apple also returns capital directly to shareholders through a dividend.

Put these together and Apple has returned more than 90% of its free cash flow to investors through stock buybacks and dividends over the past decade, a total of more than $600 billion.

I am also at a bit of a loss for words here, but in awe rather than disgust.

Is it Warren Buffett’s influence that led to this? The majority of Apple’s stock buybacks have occurred since Berkshire Hathaway took a position in Apple (although Apple started buying back stock years before Meta and Google). Or is this sort of incredibly supportive board and management attitude towards shareholders why he took a position in the first place?

I dunno. Probably both. Whatever the source, I really am kinda blown away by Apple’s decisions when it comes to free cash flow allocation and stock-based comp dilution. THIS is what capitalism is all about, and THIS should be everyone’s go-to example for how stock buybacks can absolutely work for investors.

A final thought.

For the past decade, an overwhelming tide of infinite central bank liquidity lifted all boats. Sure, companies like Apple, with an immensely shareholder-supportive board and management team, did well in the stock market, but so did companies like Meta and Google, with boards and management teams that were … errr, not so shareholder-supportive. So did companies that were even more aggressive in their shareholder dilution and stock-based comp schemes than Meta and Google. Mendacity was not just ignored over the past decade, but was rewarded time and again. Quality of board and senior management direction, where quality is defined by putting the interests of the owners of the company (the shareholders!) above the interests of the managers of the company … well, that really hasn’t mattered to the market in a long time.

I think that board and senior management quality may matter again, as the tide goes out.

I think that board and senior management mendacity may be punished again, as the tide goes out.

And that’s a market narrative I think we can all support.



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Comments

  1. BOOM Ben --Fantastic work! Reminds me of the work you did on the AMA.

    I would change only one word:

    Step 4: Wall Street/CNBC Renfields trumpet the sterilizing stock buyback as “returning cash to shareholders”, encouraging shareholders to not only ignore the transfer of their money to management, but to embrace it.

  2. Bravo! Adding Apple as an example of non-mendacity forces the reader to confront the cartoon version rather than hiding behind the uncritical popularity of the tool. I also think that the closing argument that even greater mendacity has been rewarded at a negative cost of capital seals the deal. I am sending this note to outside advisors of our endowment as required reading for their analysts who pick individual stocks on our behalf.

  3. Avatar for bhunt bhunt says:

    Thanks, Patrick! I’ll get you a PDF version of the note later today for easier distribution.

  4. The fact that companies automatically pay the IRS in cash upon RSU vesting is an interesting one and not something I had realized. It seems almost as if these companies are taking a short position in their own stock, because on the grant date they are effectively making a promise to buy back a fixed percentage (say 30%) on the vesting date. The higher the stock price goes, the bigger the liability becomes.

  5. My “favorite” is the “we are authorizing a buyback to offset dilution” canned justification… while at the same time reporting Non-GAAP to because “stock compensation is a non-cash figure”

  6. Avatar for rguinn rguinn says:

    Long the narrative, short the fact!

  7. I asked my father (32 yrs as an advisor) what percentage of Meta’s FCF was used on buybacks and how much said buybacks shrank the float. When I gave him the actual numbers his jaw dropped. Normal investors have no idea how much they’re being played by some of these companies.

  8. Fantastic observation that I had not considered.

  9. Avatar for bhunt bhunt says:

    Most institutional investors, too!

  10. Great Note! None of the companies in this note have a high gross leverage or net leverage ratio but many companies do from issuing mountains of debt to buy back shares during the post GFC financial repression era. Not only taking shareholder money via sterilization but leaving them with a levered-up more vulnerable investment too. Alas the institutional bond investors fell over themselves to buy these deals because they were “10 bps cheap to secondaries” .

  11. Hey Nick —care to share any examples?

  12. How about Boeing? Had roundly $10 billion in Long Term Debt in FY’s ‘16/’'17/'18. Recent figures $55-$60 billion. Tons of stock retired in the $300-400 range, last sale $175.

  13. Boeing is the George Romero of zombie companies: often imitated, but never truly matched in size and scope.

  14. There are too many to name here, but sticking to names that have appeared on ET, AAL was running 4x leverage pre-pandemic compared to UAL who was running 2x and DAL at 1x. All were buying back shares and issuing debt in each of the 5 years prior to the pandemic. At a higher level, the leverage ratio of the US Bloomberg Barclays Corporate index increased from 1.6x in 2010 to 3.0x in 2022. Additionally, the amount of BBB rated credits in the index increased from 36% in 2010 to 45% 2022 while share buybacks continually push new highs.

  15. Avatar for 010101 010101 says:

    As a user, google has got worse since I first started using it as a search engine, over 20 years ago. It is more like a sponsored shop window than a search engine. Just how many seven figure managers can possibly be needed to sell shop window space?

    A fun number would be the percentage of net cash that is released through stock comp that is then later on, deliberately used to repurchase a position of the company’s shares, by and for the recipients.

  16. Avatar for Btaff Btaff says:

    I totally agree with you about stock buybacks and other shenanigans that managers have been using to fleece shareholder for a while.

    However, not sure I quite understand the part about the company paying the tax part for RSUs. I missed the call on Friday so if you discussed this I apologize. I work at a large wirehouse and we are paid a % of the revenue that we generate for the firm. Part of that payment is in RSUs that vest over time. When the RSUs vest the firm takes about 30% and pays that to the IRS for me and I am left with the remaining shares with a basis at the current price and my holding period starts. I don’t view this as the company paying the IRS but me paying the IRS since in reality I should be paid in cash for the revenue I generated (in reality depending on my tax bracket I most likely will be paying more than that 30% at the end of the year for that vesting). Is this the 30% you are describing in the note that the firm is paying itself or am I missing something? Thanks

  17. Avatar for bhunt bhunt says:

    No, you’re not missing anything. And yes, this is your compensation that is being withheld by the company and then forwarded to the IRS. If the company were just a go-between on this, they would sell the withheld shares on the open market (increasing the share count and diluting investors) and send the proceeds to the IRS. Instead, the company uses shareholder money to buyback these withheld shares and sends that cash to the IRS. This is a stock buyback, but they are buying the stock directly from the employee and not on the open market. It is a monetization of your stock-based comp with shareholder cash.

  18. Great note.

    I have lots of thoughts on this and experienced a few epiphanies while reading - but the thought I am left with is that this note needs to be distributed to, read and understood by the major global governance solutions companies. Like Glass Lewis, ISS, MSCI and Kingsdale.

    I’m sure I am not the only one here with some experience dealing with proxy voting on behalf of clients, but for me it has been an eye opening experience. In my career I have experienced proxy voting going from being a complete non-issue, to being something we paid attention to only for clients who work for large corporates who may want to make sure that they are actually voting, to becoming an ESG issue to finally, today, being part and parcel of “responsible stewardship” for any wealth management/investment management company.

    In a practical/metaphorical sense - this means that the “sleeping giant of shareholders” is awakening. The collective voting power of asset managers’ (previously “silent”) clients is formidable, but the process is not without issues. An obvious one is cost, the cost of the additional research capabilities to research corporate proposals and votes. As this does not necessarily add to your bottom line it is currently being farmed out to the large governance/proxy voting service companies like Glass Lewis. And while the reports I read from Glass Lewis are detailed, it is clear that they are not “driving” the governance agenda, so much as just trying to “keep up with it”…

    I guess my point is this. If we want to make the type of practice that you so brilliantly expose in this article harder to do, then a good place to start would be the proxy voting service companies. Meaningful chuncks of shareholders on a global basis follow the advice of these companies (via their investment manager) almost to the letter when voting, and the kicker is that most companies (such as the one I work for with £50bn+ under management) will construct a letter to the chief executive of all companies where we end up voting against management - explaining exactly why we have decided to vote against them. When an issue persists, we eventually ask for a meeting with management.

    It is probably a bit naive of me to imagine that a difference can be made in this manner, but I guess I retain a shred of optimism yet!

    Em

  19. Avatar for bhunt bhunt says:

    100% Em! This is one of the focus areas that Rusty is working on with his follow-up note …

  20. I look forward to reading that.

    Out of everything that falls under the ethical investing/ESG umbrella, pretty much the only thing I still believe is worth while is stewardship via active proxy voting. Reading through Glass Lewis reports on a weekly basis I have come to realise that special research expertise is often needed in order to fully understand each company’s procedures and “language” and it is still not an area receiving a lot of focus internally. Companies want to secure a history of proxy voting (as this is now often a requirement for various “responsible stewardship” certificates and awards etc. but the detail is often lost.

    My only concern about the increased awereness of proxy voting is that if private investors start to make themselves heard better, then this will only further accelerate the trend of companies viewing “going public” as a last resort - diluting the quality and diversification of the pool of “public” companies. Already VCs have first-pick of so many opportunities.

    Ultimately, the practices you point out in the article makes me ponder really “big” questions , like What are companies actually for? What is their underlying purpose…

    And that’s when it gets really hairy. Clearly the simple/textbook answer is “to serve shareholders/owners” but anyone who has spent some time reading economic history knows that this answer has not been unequivocal during the last 100 or so years. This article from the Economist touches on some of it :What companies are for | The Economist
    but it will be behind a paywall I think…

    The main point of the article is to highlight that the nature and purpose of capitalism is up for debate through all parts of an economic cycle and that there has been a tug of war between shareholder value and a more collective type capitalism for a very long time - all the way back to the 50s and 6os.

    Personally I have started to think that the warping of shareholder-value capitalism that we are currently seeing is down to two major factors and only one of them can be considered to be cyclical.

    First of all, we are seeing a drift towards a more collective capitalism due to large companies simply reading the writing on the wall. Inequality is sky high and the environment is under so much pressure it is becoming impossible to stay laser focussed on only shareholders. Hence the corporate drift towards making regulators and the public believe that a public company does not just serve its shareholders - but also customers, staff, suppliers and the community. I don’t want to make light of the dual problem of inequality and climate change…these are massively complex problems without any easy/obvious solutions, but I can at least imagine these factors lessening in importance and I can therefore also imagine that we may yet see a return to a more owner-oriented capitalism.

    But, secondly, I also think a much more nefarious factor is at play. Nefarious is perhaps the wrong word, it is only nefarious if it is ignored. I think I have written about this in a previous post, but it relates to diminishing levels of economic growth due to the changing nature of our economy. The economy has always “changed”, but the factor doing the “changing” today is a one-direction-only force. A force that will not ebb and wane, or act in a cyclical manner - technology.

    There is so much to go into, some of which has been mentioned in previous forum posts by others, but this short article by Eric Weinstein is a good illustration I think:
    Edge.org Eric W was the source material for most of my base-layer thoughts on this.

    I digress… I guess my worry is that if we choose to fully focus our efforts on trying to fix or improve the mechanics of capitalism at this point in history, then we run the risk of ignoring the real reasons our beloved market economy is warping itself into something it wasn’t supposed to be. I absolutely applaud efforts to fight back when the ridiculous nature of it all goes too far, like you have so effectively laid out in the article, but if we zoom out and start to ask questions about the nature of the link between economic growth and capitalism then I think we will discover even more pressing issues. For example, as much as I do believe that pure self-interest can cause mendacity of the kind you highlight, I also think that it gets turbo-fueled or wide-spread once companies and people lose faith in future economic growth.

    Economic growth is the fuel and a requirement for healthy capitalism, and if growth is in terminal decline due to the exponential effects of technology, then capitalism is currently a system running on fumes… And we have to ask ourselves if our time is best spent trying to fix capitalism the way we remember it from an era gone by, or whether it is a good idea to start thinking about what a functioning system should look like in an era of exponential and deflationary technology. Not thinking about it, to me, simply opens the door wide open for ideas I don’t like the sound of…authoritarianism, Chinese style communism etc. These may seem unrealistic, but we ignore the current level of financial desperation among the masses at our peril…already we have suffered a devastating loss of societal trust (another crucial component of a well functioning capitalism), what is next?

    Perhaps I should stop drinking coffee now. It is 7am and the family will be up anytime :slightly_smiling_face:

  21. Avatar for 010101 010101 says:

    Good post Em.

    Advanced technology requires the cooperation of a great many individuals.
    The spoils from the gains made by the application of technologies are not guaranteed to flow to the authors of these new and useful techniques.
    There might be fantastic benefits to many, many of us from machine learning and genetic engineering. It is not possible for all to enjoy these benefits without a way of sanctifying the provision of these future goods, in a manner that properly rewards the necessary inputs of labour and risk. There will always be the opportunity to be selfish in a system as large as society. IMO it has become so prevalent that it is difficult to even know what is overly self-serving and what isn’t. It is too easy to manipulate others’ emotions to achieve a selfish outcome. Faux alignment, virtue signalling and many other ways that story can be disconnected from determinable facts leave just so much room for devilry.

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