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Sept. 25, 2021, 9:15 a.m. EDT

Why a tax on share buybacks could actually boost stock prices

By Mark Hulbert

Taxing stock buybacks may not hurt your stock portfolio’s performance and may even help it. This is hardly the consensus Wall Street view of a proposal before Congress to impose a 2% excise tax on stock buybacks. Many stock analysts are worried that, if that proposal were enacted, it would have a significantly negative effect .

They may be overly worried. Companies are notoriously bad market timers when it comes to planning their buybacks, repurchasing more of their shares when they are overpriced than when they are undervalued. To the extent they repurchase overvalued shares, the buybacks reduce the present value of future years’ earnings.

This consequence is too often overlooked because the short-term reaction to a company’s buyback announcement is typically positive. But if the company has overpaid for its stock, it would have been better for it to spend the repurchase amount on a corporate project or asset with a greater potential return on investment.

To that extent, it actually would be positive for stocks over the long-term if an excise tax on repurchases discourages companies from engaging in such value-destructive behavior.

Buybacks and M&A

No one can deny that it’s a bad deal to exchange a fairly-valued asset (cash) for an overvalued one (overpriced equity). Yet, since there is no indisputable method for determining whether a stock is in fact overpriced, it’s surprisingly difficult to document this mathematical truth in the real world.

The intriguing straw in the wind is that companies repurchasing their shares are, on average, overpaying. That is evident in the close correlation between repurchase activity and mergers and acquisitions. M&A plays a strong role in the stock market and it has been a reliable contrarian indicator — with high M&A volume typically preceding periods of below-average stock market performance.

Over the past couple of decades in which repurchases have played a major role in the market, their total volume has risen and fallen in close lockstep with M&A volume (see the chart below).

Matthew Rhodes-Kropf is a finance professor at MIT and an expert in the history and meaning of M&A activity in the U.S. In an interview, he told me that “each of the last six great merger waves on record” — going back more than 125 years — “ended with a precipitous decline in equity prices.”

The correlation in the two data series in the chart above is not proof that stock buybacks have had a destructive effect on companies’ long-term growth potential. But the correlation makes sense, according to William Bernstein, co-principal at Efficient Frontier Advisors . In an interview, he pointed out that, for both M&A activity and repurchases, high volumes reflect “the exuberance of high valuations.”

The bottom line? It’s possible that any tax bill that discourages buybacks will have a short-term negative effect on the stock market. But, once the dust settles, we may discover that the present value of companies’ future earnings has gone up as a result.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at

More: How the new and higher taxes that Biden and Congress are pushing would hurt stock investors and consumers

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