Beware of Stock Buybacks
Stock buybacks - Textbooks love them, but do they have a nefarious side?
Stock buybacks are described in academic material as an ‘efficient way to return capital to shareholders’. Buybacks pass capital back to stockholders without triggering a taxable event, unlike dividends which are taxed. Buybacks remove shares from the market to improve future earnings per share (EPS). Buybacks help future cash flow by removing shares that receive dividends from the market. And the announcement of a buyback program signals the company is strong and typically sees a short-term increase in share price. Who can argue with that?
We can Anon….we can.
Despite all the positives listed above, and the general investor sentiment that buybacks are good, in practice we view them as one of the biggest destructions of shareholder value.
Yes, the obvious one is that executives tend to start and pause buybacks at the worst possible time. When the stock market is up, the economy is strong, and cash flow is good, management tends to increase their share buyback. This leads to overpaying for their stock. Consequently, when everything tanks and the share price is at a bargain, executives tend to hoard cash and pause the buyback…or worse reissue shares at a lower price point.
But our issue with buybacks run much, much deeper than that.
We will warn you, after your eyes are opened to the truth on buybacks, you can’t unsee it. If you like a worldview that reads like an “Intro to Finance” textbook, don’t read on.