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Why don’t buybacks seem to correlate with corporate strength?

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If you believe stock buybacks are an indicator of corporate optimism, or a sign that companies are effectively inverting the U.S. tax code, prepare to be disappointed.

They aren’t supposed to be a measure of corporate strength. Stock buybacks are a strategic financial maneuver to invest in capital, buy debt, hire and pay dividends. But they aren’t necessarily a reflection of corporate optimism.

Sometimes company buybacks can signal that a company wants to return cash to shareholders quickly, as a way to reduce outstanding shares. It isn’t new to stock buybacks, but it is a growing phenomenon, partly because a number of companies have been able to skirt Securities and Exchange Commission rules.

New rules that will take effect after Jan. 1, 2020, may change that. These rules require that companies reveal the impact of stock buybacks on future earnings and the extent to which the buybacks distort earnings and asset returns. The companies are expected to add to their disclosure and explanations about how stock buybacks are treated by industry.

“We think this will increase disclosure going forward,” Chris Richardson, executive director of the research organization Responsible Investment Research Institute, said in an interview. “In the past, disclosures have tended to be really thin. They haven’t really been very transparent.”

There’s not a lot of immediate clarity as to how the new disclosure requirements will be enforced. Yet the rules will almost certainly have a large and transformative impact on how stock buybacks are reported, Richardson said.

Though he doesn’t see buybacks as an indicator of corporate strength, Richardson does think they are a factor behind how investors think about companies’ prospects, and pay attention to the size of buybacks. Companies are subject to inquiries about buybacks by the Securities and Exchange Commission, but they are not required to disclose the numbers. That change is expected to be implemented early next year.

The new rules will require that, after the accounting change takes effect, companies disclose stock buybacks in earnings releases and also separately in the annual 10-K corporate filings.

Companies are expected to provide additional reasons why they buy back shares, such as as a way to reduce their outstanding stock. Companies will have to justify the size of their buybacks in smaller increments than now required.

“We are very excited about this and the flow of information by companies is going to be really interesting,” Richardson said.

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