Buybacks are not my favorite way to redeploy excess capital, in general. But let me describe to you when they are useful and when they are not [taken from this article]:
Buybacks are preferred on a taxation basis to dividends.
But buybacks are especially good when the stock is trading below its franchise value, and especially bad the further above franchise value the stock is trading.
Using slack capital to improve operations, or do little tuck-in acquisitions is probably best of all. Organic growth is usually the best growth, and small acquisitions can facilitate that. Small acquisitions are usually not expensive. Be wary of acquisitions to increase scale, they don’t work so well.
Paying a dividend makes management teams more cognizant of the cost of equity capital, which makes them more effective.
In the reinsurance business in Bermuda, companies with slack capital tend to buy back shares below 1.3x book value, and issue special dividends if they are above that level.
The whole article is worth a read, but there is one more factor that drives buybacks, especially illogical buybacks where they pay more than the per share intrinsic value of the company: they don’t want to get taken over by another company. After all, the current management team may never have such nice jobs ever again.
Buying back stock at uneconomic prices temporarily keeps the stock price high, and removes cash from the balance sheet that an acquirer could use to help purchase the company. We haven’t seen it in a while, but some companies under threat of a takeover would do a semi-LBO and borrow a lot of money to buy back stock, making a purchase of the company less attractive.
Thus, I’m not sure we could ever get rid of buybacks, even when they don’t make sense, except perhaps in the long run by selling the shares of companies that are too aggressive in the buybacks.
I rarely disagree with Josh Brown, but I did not find the HBR article he cited criticizing buybacks to be compelling. I would find it really difficult to believe that management teams avoid projects offering organic growth at rates exceeding the implied yield from buying back stock. Also, there are many different ways to run businesses in our country, and if public companies suffer from a buyback bias, then private companies might be able to think longer-term, and invest in profitable organic ventures.
Thus I would not blame buybacks for other problems in society; I might blame too much investment in residential housing and financial institutions, but even then, I would not be certain. What we invest in as a society does affect future growth, but it is difficult to see where the end-investments take place. Money from a stock buyback might get redeployed into a business startup. It may be that public businesses are light on organic investing, and take less risk in investing via buybacks. But that is why we have startups, private equity, etc., much of successful of which go public or get acquired by public companies.
Anyway, just a few thoughts…