There has been a lot of coverage lately over whether stock buybacks are beneficial to investors.
First, let’s recap why companies repurchase their own shares, and then present arguments for and against the practice. Finally, we’ll list U. S. companies that are just throwing away their (and possibly, your) money.
Publicly traded companies issue additional shares to raise cash to fund projects or acquisitions, or to award employees with stock. Issuing shares dilutes the share count, which means if you hold shares, your percentage ownership of the company declines.
Many companies repurchase enough shares in the open market to make up for the dilution caused by the issuance of new shares. Some companies go further, buying back even more shares to lower the share count, which boosts earnings per share.
Arguments for buybacks
The biggest argument in favor of net buybacks is that they boost earnings per share, something that can translate to a higher share price. After a board of directors authorizes a buyback plan, a company’s management may accelerate or decelerate the purchases, depending on cash flow or how the shares are trading in the open market.
If a company is performing well – sales and profits are rising, for example – buybacks can have a wonderful effect on the stock price.
Another argument in favor of buybacks is that they are more ‘tax efficient’ than dividends, unless you are holding the shares in a tax-deferred retirement account. If you receive dividends, you may have to pay taxes on them. If your shares rise in value, you pay no tax unless you sell them for a profit.
This post was published at David Stockmans Contra Corner on April 7, 2016.
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