Buybacks Aren’t Evil
Lately, it has become very fashionable to be against stock buybacks. Critics argue that corporations repurchasing shares are killing the American economy and enriching CEOs at the expense of the working class. In the public’s mind, corporate executives are spending money paid out in buybacks on caviar and private planes instead of using it to hire more workers. However, while the practice of repurchasing shares is a convenient scapegoat for rising inequality in America, most accusations against buybacks are unsubstantiated. There’s nothing evil about corporations buying back their own stock. And when used properly, buybacks can be an extraordinarily efficient tool for allocating capital.
Buybacks are simple. However, due to their somewhat newfound controversy, they tend to be both overcomplicated and presented with bias. A stock buyback is simply when a company buys its own stock either on the open market or through a tender offer. This process results in a lower number of total shares outstanding and a concentration of ownership for existing shareholders. To illustrate this phenomenon, you can imagine three partners opening up a restaurant, all with an equal ownership in the business. If the restaurant does well, it will compound its retained earnings over time and use a portion of those earnings to reinvest in the business. If partner A wants to retire and dissolve his or her share in the business, partners B and C have the option of “buying back” partner A’s ownership interest. Nothing is forced upon any of the three shareholders. If partner A is offering an attractive price for his or her interest and the restaurant has all the capital requirements it needs for intelligent growth prospects, then a buyback is a perfectly logical decision for partners B and C. Using this simple illustration, buybacks don’t seem particularly evil or convoluted, and it really isn’t any different for corporate America’s publicly traded companies.
One of the leading criticisms against buybacks is that they come at the expense of workers and profitable reinvestment in the general economy. Opponents of buybacks argue that every dollar spent on share repurchases is a dollar that could be spent growing business activity or increasing employee salaries. In reality, it isn’t that simple. For one, it’s hard to know what corporations would have done if they weren’t allowed to repurchase shares; just like it’s hard to know what the U.S. election would have been like if we didn’t have a rampaging global pandemic. The actual impact of buybacks is very difficult to estimate. But the claim that buybacks are destroying jobs and disincentivizing businesses to reinvest in the economy is entirely speculative. In fact, empirical evidence suggests that buyback activity and reinvestment are positively correlated, as both have substantially increased since the 2008 financial crisis. Furthermore, contrary to what some critics may claim, the capital used to repurchase shares doesn’t disappear into the ether. When shares are bought back in the open market, the capital has to be reinvested somewhere else. As a result, capital flows away from businesses that don’t need it and flows into businesses that do—which is exactly how a market system is supposed to work. In addition, contrary to what many pessimists may believe, corporate executives aren’t the only people who have something to gain from successful buyback programs. Middle-class workers with pension plans and 401(k)’s benefit greatly if the per-share value of publicly traded American businesses increases over time.
Something else that is particularly interesting is that many opponents of buybacks who argue that share repurchases come at the expense of profitable reinvestment also argue that repurchases are bad because they increase shareholder value. Well, if buybacks are robbing shareholders of future profitable investments, how can they also increase shareholder value? After all, stocks can’t offer returns that are much better than how the underlying company performs in the long run. Critics of buybacks who preach these paradoxical arguments have completely lost sight of the fundamental idea that there is no moral taint to increasing the per-share value of a company’s stock over time. If anything, it is the fiduciary responsibility of corporate managers to do so. Henry Singleton, the former CEO of Teledyne, was a manager who sought out to do just that. From 1963 to when he stepped down as chairman in 1990, Singleton delivered a whopping 20.4% compound annual return for his shareholders compared to a meager 8.0% compound return for the S&P 500 during the same period. One tactic Singleton employed to deliver these sensational returns was the intelligent use of buybacks. Between 1972 and 1984, when a handful of recessions fueled by high oil prices, economic stagnation, and rampant inflation resulted in record-low U.S. stock prices, Singleton opportunistically repurchased over 90% of Teledyne’s total shares outstanding. Yet, during Singleton’s tenure, Teledyne employed thousands of workers, spent hundreds of millions of dollars on reinvestment, and had a CEO that exercised the uncommon sense that Wall Street lacked. Did Singleton act immorally when he bought back all of those shares for Teledyne? The answer to that question is a resounding no.
While Singleton’s track record demonstrates the merits of buybacks, there are certainly some valid criticisms. When executed incorrectly, share repurchases could go against the best interests of shareholders. Jeff Immelt, the former CEO of General Electric, provides a textbook example of how this can happen. From 2016 to 2017, GE repurchased $24 billion of its own stock at sky-high valuations. Those shares were purchased at an average price of around $30. Today, those shares are selling for about a third of that. At the time of those repurchases, the company had numerous underperforming businesses and was saddled with over $100 billion in debt. Paying down debt and divesting underperforming segments should have preceded the priority of buybacks by a long shot, but it didn’t. During Immelt’s tenure, shares of General Electric declined by about 30% while the S&P 500 more than doubled. GE’s buyback program certainly wasn’t a demonstration of capital allocation at its finest hour. But still, there was nothing evil about it. Immelt didn’t gain anything from buying back GE’s stock at outlandish prices. In fact, it cost him his job. GE’s earnings per share were not artificially inflated. In fact, they were negative in the years following the buyback program. Immelt’s buyback program was foolish, but it wasn’t evil.
When considering buybacks, managers of publicly traded companies should follow a simple two-question checklist. Is there enough capital retained for intelligent growth prospects? And is the stock selling for less than what it’s worth? If the answer to those two questions is yes, then buybacks are a perfectly logical way to allocate capital and there shouldn’t be the slightest moral taint associated with it. There are ways specific buyback programs can do more harm than good. However, propositions like the Reward Work Act that seek to prohibit open market purchases are ludicrous. It isn’t buybacks themselves that deserve criticism—it’s the specific buyback programs that do. Believing share repurchases are evil because they can be misused makes about as much sense as believing drug cartels are good for society because they give money to the poor. Still, like anything, buybacks can be taken to levels of extreme excess. I don’t think we’ve reached that point yet. But in Henry Singleton’s own words, “if everyone’s doing them, there must be something wrong with them.”