Stock Options for Management
The 5 companies in the top 15 buyback list that are also in the top 15 issuance list are Cisco, Oracle, Johnson and Johnson, Wells Fargo, and Merck. Although all five have massive buyback programs, the programs coincide with significant share issuance. Largely responsible for this overlap is employee compensation, in particular, stock options.
When management redeems stock options, new shares are issued to them, diluting other shareholders. A buyback is then announced that roughly matches the size of the option redemption. This facilitates management’s resale of the new stock they were issued in the option redemption. Buyback? Not really! Management compensation? Yes.3
Because the stock options a company issues its management dilute the value of its stockholders’ shares, companies often repurchase their stock to offset this dilutive effect. The net impact is a transfer to management of more of a company’s cash flow than is reported as compensation on the income statement. Irrespective of the intent of the company to reduce the dilutive impact of its options-based stock issuance with buybacks, the reality is that the dilution is not always totally offset.
But We Must Lift the Veil Higher…
Upon closer examination, we find that the cash flow statement often fails to report the majority of a company’s stock issuance. How do we know this? We compare the market capitalization of a company at the end of the year to its market capitalization at the beginning of the year, adjusted for the change in the company’s stock price. If the market capitalization is up 10% and stock price is unchanged, there must have been 10% new share issuance. This analysis allows us to determine the amount of a company’s stock buybacks or issuance. We then follow a thorough process of fundamental research into each company’s corporate actions as described in its press releases and by the financial media to determine the source of and reason for the new issuance unexplained by the cash flow statement.
Aggregating the equity of all publicly held U.S. corporations, we find that U.S. companies issued stock equal to $1.2 trillion in 2014. Whereas part of this aggregate market issuance was in the form of initial public offerings, far more stock was issued by existing companies, the largest of which are listed in Table 3.
Why are companies issuing such large amounts of stock? In addition to stock options for management, we find that a substantial amount of new issuance is to support companies funding merger and acquisition activity. With so much new issuance, the potential benefit of stock buybacks may not be realized by the investor.