With a lower repatriation tax rate, the new Tax Cut and Jobs Act encourages companies to bring upwards of $2.5 trillion of offshore capital back to the U.S. — and company executives and boardrooms are developing allocation plans to put this fresh capital to work. To wit: There’s discussion of Apple doing just that with the $250 billion it’s bringing back home. While many companies will opt to increase dividend payouts, increase capital expenditures and pay down debt, some will respond by increasing stock buybacks.

Over the past decade, companies have poured approximately $4 trillion into buybacks, reducing share count and contributing to the historic rise in stock prices. While stock buybacks help lift the market, shareholders should ask themselves if the price appreciation has been worth the cost in lost capital.

A common trap for investors is to confuse the value created by returning cash to shareholders (i.e. price appreciation) with the long-term value that could have been created by investing that capital in new product development and operational improvements.

There is a dark side to stock buybacks that most investors don’t realize. Put simply, buybacks are a form of financial engineering. Because buybacks reduce the number of outstanding shares, executives use them to make earnings “look better” by spreading earnings over fewer shares. This creates the illusion that earnings are rising, when in reality they may not have changed.

Even worse, for companies that continue to issue new shares in employee stock plans, share buybacks are akin to flushing the capital down the drain, because they shift cash off the companies’ balance sheet and into the hands of executives. Here’s how it works: Executives sell held stock to the company, engineered earnings rise enough to allow them to meet performance hurdles, and the company’s board grants the executives more shares. Even though they sold their stock in the buyback, the new grants allow executives to maintain their ownership position. As a result, a significant portion of the buyback capital never permanently reduces the share count.

Companies are supposedly buying back shares because they believe the stock is undervalued. With the market reaching 52 consecutive all-time highs in 2017 and stocks arguably overvalued, I find this hard to believe.

Ethical implications aside, however, stock buybacks have moved the needle on stock prices in a very positive way over the past few years — and newly repatriated capital should accelerate buybacks across a broad swath of stocks.

A number of large companies, including Cisco Systems, NetApp, Qualcomm and Amgen, are likely to pour capital into buybacks, as they have in the past, which could cause their share prices to increase accordingly. Why these companies in particular? They have the largest ratios of offshore cash unlocked by tax policy to market value.

Investors should expect these companies to announce even larger buybacks than they’ve made in the past and stock prices may lift accordingly. In fact, we think large-cap buyback stocks will post outsized performance in the first half of 2018.

Top 7 Buyback Companies for 2018

Company

Ticker

Market Cap (Bil) 12/28/17

Approx. Offshore Cash (Bil)

% of Market Cap

Cisco Systems

CSCO

$191

$68

36%

NetApp

NTAP

$15

$5

33%

Qualcomm

QCOM

$96

$30

31%

Amgen

AMGN

$129

$36

28%

Apple

AAPL

$895

$230

26%

Oracle

ORCL

$198

$48

24%

Microsoft

MSFT

$659

$113

17%

Total

 

$2,183

$530

24%

Source: Bloomberg, 2018

At the same time, investors should also be on the lookout for large-cap companies that use newly repatriated capital in other, arguably more strategic ways, such as by increasing dividends and spending it on the business in ways I mentioned earlier. By diversifying their bets, portfolios should be positioned to take advantage of the many benefits of the new tax act.