Share buybacks, also known as share repurchases, have been a common theme in tech companies' earnings this year. According to Cornell University assistant professor Nick Guest, the main benefit of share buybacks is that it allows management to signal that they believe the stock is undervalued. However, some criticisms of buybacks, such as companies using them to manipulate their share prices, have not been necessarily proven by the data.
Guest noted that there isn't a lot of evidence to support the argument that share buybacks are associated with excessive executive compensation or that companies that buy back shares sacrifice growth and profitability by not having as much cash available for investment opportunities. In fact, evidence suggests that there isn't any large-scale, on average evidence of those things.
Recently, Alphabet announced a $70 billion buyback, which, according to VerityData analyst Ali Ragih, is slightly large for them but not when compared to the market-wide. Apple also announced a $90 billion stock buyback this week.
The benefits of share buybacks are that they have more flexibility than dividends and are easier to temporarily cut during downtime. Moreover, repurchasing shares reduces the amount of cash that could be misused on management's pet projects. Repurchased shares can also be used to compensate employees.
According to Ragih, the best time to do a buyback is when the valuation is low because companies get the most bang for their buyback. Companies get more shares for the same overall dollar value of spend when the stock price is lower.
However, buyback backlash has increased in recent years. Critics say that they enrich companies and executives without improving the overall economy. Over time, shareholders may see fewer buybacks if that trend continues. If the disincentives increase, such as a 4% tax or other limits on what managers can do in terms of selling their own shares after the company has bought back shares, and other potential restrictions, some firms might decide to retain the cash instead or switch to dividends, which both could have negative consequences. For example, dividends are taxed as income tax, whereas repurchases typically generate a capital gain, creating additional costs for shareholders.
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