Stock Buybacks

The Controversy Around Stock Buybacks Explained

At face value, the notion of companies buying back shares in their own stock may seem pretty benign.

Q4 hedge fund letters, conference, scoops etc

But as soon as trillions of dollars are being poured into any single cause – regardless of how innocuous it may sound – there is always the potential to make a lightning rod for controversy.

With stock buybacks totaling $1.1 trillion in 2018, they’re at the center of discussion more than ever before.

Stock Buybacks

What are Stock Buybacks?

When publicly-traded companies want to return money to shareholders, they generally have two options.

The first is to declare a dividend, but the other is to repurchase its own shares on the open market.

Although it seems meta, stock buybacks are a way for companies to re-invest in themselves. Each buyback decreases the amount of shares outstanding, with the company re-absorbing the portion of ownership that was previously distributed among investors.

In other words, buybacks are somewhat analogous to buying out a business partner – they allow the remaining partners to own a higher share of the company.

Pro vs. Con

With the amount of stock buybacks rising to historic highs, they have been front and center in 2019. Here are what proponents and opponents are arguing about.

Pro Case:

Proponents of buybacks say that if they are done rationally, buybacks (like dividends) are just another way to return cash to shareholders. Stock prices for companies that have bought back shares are also higher, in general, than other companies on major indices like the S&P 500.

Con Case:

Opponents of stock buybacks say that they increase inequality, and that executives make short-term oriented decisions around buybacks that allow them to maximize personal gain. In other words, when a company probably should be investing in its people or its business, the company is instead giving money back to the wealthy owners – and only they benefit.

The Bottom Line

While both sides make a compelling argument for different reasons, the only real way to evaluate stock buybacks is based on the merits of individual companies.

If the company is returning money to shareholders because it is the best allocation of capital, then it can make perfect sense. If the company is doing it at the expense of growing its business and the wages of employees, one can see why stock buybacks may rub people the wrong way.

Article by Visual Capitalist


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