Will Stock Buybacks Kill Your Portfolio?

It’s been a busy year for buybacks, as the “evil corporations” continue to repurchase stock from shareholders at a higher rate than we’ve seen in quite some time, and so far, they show no signs of stopping. In fact, the pace might be picking up even faster as we start to enter earnings season.

So, with more and more shares getting absorbed back into companies across America, that begs the following questions – why are these corporations buying back stock so rapidly, and is it good for the shareholder?

Why Repurchase Stock?

Whenever a prolific company decides to buyback stock, it always prompts the same response from analysts, talking heads, and politicians who mindlessly parrot the following message:

Corporations buyback stock to temporarily boost stock prices and line the pockets of management via bonus payouts on stock options… screwing the shareholder in the process and putting the company’s long-term viability at risk.

These so-called “experts” claim that by buying back stock, corporations are spending cash that could be used elsewhere – like research and development, or bringing more competitive products to the market.  Or, at the very least, the shareholder suffers because the cash used for the repurchasing of stock could have instead be used to reward investors with dividends.

It would be great if we could merely label buybacks as being “good” or “bad” – they’re something that we see a lot in the market, and it would surely make life much easier for investors.

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But sadly, stock buybacks are not that simple. Each and every one is unique, and most are done with the shareholder’s best interest in mind.

Buybacks, more than anything else, are simply a financial decision on how to best allocate the use of excess funds.

Yes, that’s right – excess funds. Not funds that have already been dedicated to R&D (research and development) or dividends.

Choosing to issue a buyback is a financial decision that’s determined by what type of company it is and what stage it’s at in its natural lifecycle. They aren’t caused by fat-cat executives, smoking cigars while dreaming up new ways to shortchange their investors.

For example:

A relatively new tech company is going to want to plow profits back into R&D and product innovations to accelerate the growth of the company. It’s unlikely that such a company will ever have excess cash available for buybacks or dividends.

On the other hand, a more mature company (particularly one with low R&D costs) that’s already paying a healthy dividend might find it to everyone’s best interest, shareholders included, to apply any excess cash to buybacks.

And I don’t think it came from a place of fear or helplessness. In my opinion, Zuckerberg’s move was a strategic, preemptive strike in the upcoming war for crypto ad revenue.

So, while buybacks would make sense for some companies, they don’t make sense for others – as a result, they can’t be universally labeled as being “bad” or “good”. They’re a financial strategy that depends on the situation of the company considering it.

Do Buybacks Drive Up Stock Price?

On the surface, you would think that buybacks could be a catalyst used to drive up stock prices. After all, they reduce the number of outstanding shares, which in turn increases earnings-per-share.

However, there’s one thing wrong with that assumption…

When a company buys back its stock, it’s publicly known.

And when it comes time to report earnings, the effect of the buyback is publicly known as well – meaning that analysts will account for it when determining how impressive the earnings report is, typically diminishing any boost that the earnings report would have had on the company’s stock.

As a result, the temporary increase in stock price provided by a buyback is typically offset by the deflated earnings report.

Now I’m not saying that corporations haven’t issued ill-advised buybacks in the past. It has happened before, and it will happen again – sometimes to the detriment of the shareholder.

But these are somewhat rare cases, and in every one of them, the buyback itself isn’t causing issues– it’s poor leadership.

The buyback is simply a financial decision on how to best utilize excess cash that a company amasses. If a company is already properly filling all of its departmental buckets evenly (most notably those focused on future growth) and pays a nice dividend, then a stock buyback makes perfect sense.

If a company has long-term debt at a very low-interest rate, coupled with excess cash, it still might make sense to buyback the stock instead of paying down the low-interest debt.

Why?

Because if their stock is undervalued, one of the best things a company can do is buy back company stock and then re-issue the shares down the road at a much higher price.

At that point, they could then pay down their outstanding debt, issue dividends, expand operations, or do anything else that will help the corporation grow.

So, the next time you hear about these “evil corporations” that buyback stock at the expense of the shareholder – please consider that most of the time, it’s just not the case.

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