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I’VE BEEN READING UP on stock buybacks because I want to know how they’ll impact my investments. As best I can gather, there are two schools of thought: Those who love them—and those who hate them.
Those who love them point to the reduction in the number of shares, which means the value of those that remain should increase. Earnings per share (EPS) is net income divided by the number of shares, and EPS increases when shares decrease. To me, this artificially increases earnings and doesn’t in any way indicate the company’s health has improved. Did the company make more money on what it actually sold? No, there are just less shares to go around.
I guess I’ve already said enough about those who love them. Then there’s me, who hates them. First of all, I’d rather get a dividend or increased dividend. But I also wonder if that money couldn’t have been put to better use investing in the company’s future growth.
It might make sense to buy back shares when they’re cheap. Unfortunately, too often the opposite is the case. As CEO Jamie Dimon put it recently, JPMorgan Chase’s reason for buying back shares was simply because their “cup runneth over.” Suffice it to say, this market isn’t cheap, but companies like Apple, Alphabet and others are buying back stock like crazy.
What really galls me: Bonuses to company executives are often tied to share price growth. Now that’s manipulation at its finest.
I agree that buybacks are valid only if the execs purchase shares when they are at fair value, or undervalued. If this is met, I have no issue with buybacks, as I essentially acquire more of the company with no cash outlay required. Say 5 investors each own 20% of a company, and the execs buy back 20% of the shares, with all of them sold by one owner. Now each remaining owner owns 25% of the company with no personal cash outlay required. This is much more efficient than paying tax on a dividend, and going back into the market to buy 5% more of the stock.
Buybacks may distort EPS but they do not inflate earnings :>).
A rational investor should almost always prefer buybacks because 1) it allows them to control the timing of taxable events and 2) sales of shares (in the absence of a dividend) are usually taxed at cap gains rates. CG rates are lower than regular income rates, and dividends count as regular income. There are some unique cases that are exceptions.
However, dividends are psychologically reassuring, and that has value for some investors (and that makes this “rational” also. We all need to be able to sleep at night without worrying about our investments.)
This said, I think buybacks quietly enable business executives to pocket insane amounts of money in addition to their official ‘salary’. I personally think the BOD of just about every company in the S&P 500 is morally guilty of financial malfeasance with respect to executive pay.
Dividends are money in my pocket now. I benefit from a buyback only when I sell. I never sell. Very few companies initiate buybacks when the stock in undervalued. Overall I prefer dividends to buybacks.
Management is usually in the best position to determine if the shares are undervalued, and if they are, buy-backs can be a good use of cash. But very, very few companies purchase their stock when it’s on sale. A lot of companies buy their shares to offset the issuance of stock awards, and most of these are probably issued to top management. Executive compensation is a black hole, but I’ve generally seen that the people at the top take care of the people at the top. Whatever metric or metrics you tie to compensation or bonuses, they will generally find a way to meet them. I believe having to pay a cash dividend provides “some” discipline on management, although not always.