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Buybacks: Pros and Cons

Last Updated on 10 February, 2024 by Abrahamtolle

https://aswathdamodaran.blogspot.com/2014/09/stock-buybacks-they-are-big-they-are.html

 

A regular dividend gets sticky, buybacks are no obligation to continue

An intiation of a regular dividend is hard to reverse: it’s at risk of attracting what Benjamin Graham called “coupon clippers” in The Intelligent Investor (insert his quote). Many shareholders are not willing to see a decrease in the dividend, even though management might have good reinvestment oppurtunities.

Shareholders in general don’t see future buybacks as obligatory as dividends.

Cost of equity higher than cost of debt

Cost of equity is always higher than the cost of debt, thus making added value to existing shares.

Buybacks are tax-free compared to a dividend

Management always argue their stock is cheap

Buybacks are done without detailed analysis

Buybacks often done at prices above intrinsic value

Buybacks manipulates stock based compensation scheme

When executive pay is partly or wholly in stock options, executives sell their stocks in the open market, where the company effectively spends money on wages when buying back shares. This is an expense, meaning many adjusted numbers are very misleading on the expenses.

Not all treasy stocks get retired

Not all shares bought back are retired. Some are used to issue restricted stock units (RSU) for compensation. In practice this means these stocks are used for wages.

Perverse incentives

Many CEOs are awarded when EPS increases a certain amount. Buybacks increase EPS even when earnings are flat. Without adjusting for buybacks, the management can be awarded even though there are no improvements in the business.

If a company borrows money for buybacks, which has been quite normal over the last decade, the shareholders are left to pay the interests while the management increase their compensation.

 

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