How the Fed's rate hikes sent stock buybacks plummeting
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The pace of stock buybacks among companies in the S&P 500 has fallen by $106 billion in the space of five quarters, to below pre-pandemic levels.
Why it matters: This is one of the more visible areas where the Fed's rate hikes are showing up in corporate finance.
How it works: Stock repurchases are sometimes financed out of profits, but when they're not they're a way of building leverage.
- When rates are low, companies borrow money cheaply and use that money to buy back their stock. The amount of debt outstanding goes up while the amount of equity outstanding goes down — a tried-and-true way to goose stock returns, or at the very least prevent dilution from massive equity grants to executives.
What's new: Higher rates make it much more expensive to finance buybacks in the bond market.
- There's also now a 1% tax on share buybacks, effective as of the beginning of this year, making them less attractive relative to dividend payments.
What's next: The buyback tax could rise as high as 2.5%, says S&P's Howard Silverblatt, given that it's one of the few areas where lawmakers on both sides of the aisle are OK with raising taxes in the face of fiscal constraints.
The bottom line: The combination of the buyback tax with higher-for-longer interest rates has proved to be a great way to bring share repurchases back to earth.
