It’s Time to Stop Demonizing Buybacks

See Stock Buybacks Aren’t Bad. They Aren’t Good, Either by Jason Zweig of The WSJ. Excerpts:

"Don’t let a handful of anecdotal examples blind you to the broader evidence. A clear-eyed look at some of the rhetoric swirling around buybacks will show whether it holds up.

Buybacks starve companies of capital they could deploy more profitably by investing in the growth of their businesses.

This critique implies that the same management we shouldn’t trust to allocate excess capital correctly in a buyback will allocate it correctly for other purposes.

Expecting oodles of surplus cash not to burn a hole in the typical CEO’s pocket, however, is like putting a pile of raw meat in front of a lion and expecting it not to disappear.

My favorite examples come from the 1970s, when—just like now—giant oil companies had vastly more capital than they could plow back into their existing wells.

Instead of buying back shares, in 1979 Exxon Corp. bought an electric-motor maker for $1.2 billion—only to bail out a few years later, barely breaking even. Exxon also pumped at least $1 billion into futuristic office equipment—only to back out of those businesses, too, by the mid-1980s.

Exxon’s then-rival, Mobil Oil Corp., spent more than $1 billion to buy a company that made cardboard boxes and ran the Montgomery Ward department-store chain. That flopped, too.

Companies have been artificially hyping their market value by repurchasing their own shares.

A new study, “Share Repurchases on Trial,” by accounting and finance professors Nicholas Guest of Cornell University, S.P. Kothari of the Massachusetts Institute of Technology and Parth Venkat of the University of Alabama, analyzes the stock returns of thousands of companies from 1988-2020, comparing those that repurchased shares against firms that didn’t, adjusting for their size and other factors. In the year of a repurchase, companies that did large or frequent buybacks had slightly lower—not higher—returns. Over longer periods, their returns were indistinguishable.

Research published in 1967 showed similar results. 

Companies doing buybacks invest less in capital expenditures or research and development.

Younger companies with great prospects for internal growth tend to plow all their cash back into the business, leaving nothing for buybacks. As companies mature, their growth opportunities dwindle and their business generates more cash than they need, making share repurchases an appropriate choice for the surplus.

So, on average, accelerating companies don’t do buybacks, while decelerating businesses do. Investors tend to pay more for fast-growing stocks, so the short-term market performance of slower-growing companies doing buybacks turns out to be a bit lower.

In general, it isn’t that companies invest less because they’re doing buybacks. It’s that they do buybacks because they have less left to invest in.

Buybacks are on the rise because overcompensated CEOs are using them to fatten their own pay.

While the raw dollar amounts of buybacks have risen, as a percentage of the total value of the U.S. stock market they have shrunk by almost half since 2007—to roughly 0.7% from 1.3%, according to S&P Dow Jones Indices. The buyback boom has been dwarfed by the rise in stocks overall.

"What’s more, the “Share Repurchases on Trial” study finds that CEOs of companies doing buybacks don’t earn noticeably more compensation—including salary, bonus and stock options—than those at comparable companies that aren’t repurchasing shares. On average, CEOs doing buybacks don’t even earn 1% more in total pay."