Stock buybacks: Good and bad
When companies buy back shares of stock, many investors are pleased. The shares are essentially retired, leaving fewer shares, each of which will now have a bigger claim on the company’s earnings.
(Imagine a pizza being cut into six slices instead of eight.)
Buybacks have been executed in droves in recent years. Companies spent $495 billion on them in 2016 and about $696 billion in 2015.
In the recent third quarter, Apple and General Electric led the pack of repurchasers, respectively buying back $7.2 billion and $4.3 billion worth of their shares. It’s a way to reward shareholders without making a taxable dividend payment.
Share repurchases are not always smart, though. Sometimes shares are bought back when they’re overvalued, in which case management is wasting shareholder money and destroying value.
The money could be better spent in other ways, such as reinvesting in the business or paying dividends.
The decrease in overall buybacks between 2015 and 2016 might reflect the ascent of the stock market in recent years, with many managements deciding to cut back on buybacks. Sensible buybacks happen when shares are undervalued. Superinvestor Warren Buffett, as an example, has said that he will snap up shares of his company Berkshire Hathaway only when they fall below a certain level.
Buybacks can also be used to make a company’s earnings per share (EPS) look like they’re growing faster than they are. For example, imagine a company with annual earnings of $100 million in both 2015 and 2016. Let’s say it has 100 million shares in 2015 and buys back 25 million in 2016, leaving it with 75 million shares.
Its EPS for 2015 is $1, but for 2016 it’s $1.33 ($100 million divided by 75 million) .It looks like earnings rose, but they didn’t.
Keep stock buybacks in mind when you study companies as possible investments, and don’t get overly excited by them. Overall, S&P 500 component companies buying back stock have outperformed the S&P 500 in recent years, but not every repurchaser is an outperformer.