There’s nothing inherently wrong with buybacks and returning capital to shareholders. But can buybacks be abused? Of course. Like anything else. But it’s a governance problem. It’s not because the tool is wrong. Share buybacks is a board decision. Directors have to approve the buyback. Management decides the level and timing of share buybacks. The key question is “Is the board fulfilling their fiduciary duty in acting in the best interest of the corporation?” Or are they acting in their own self-interest?
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One legitimate criticism of buybacks is that companies tend to be bad market timers. They reduce buybacks when their stock is suffering and boost them when the stock is riding high. Lumen Technology comes to mind. In 2021 Lumen spent $1 billion buying back shares around $12 but when the stock was traded at $2 two years later, the buybacks totally stalled. With that approach, Lumen destroyed a lot of value. Henry Singleton did the opposite: Buy low, sell high.
Another governance problem is using buybacks as a tool for financial shenanigans. Keep an eye on executives using buybacks to boost their compensation. If part of management compensation is linked to growing EPS, it’s one area I would for potential buyback abuse. Buyback shares and boost EPS. Boost EPS and you boost the share price. Boost the share price and you boost the value of management’s stock options. Another financial shenanigans game is using buybacks to hit quarterly EPS. Short-termism is the enemy of long-termism.
While there is nothing wrong with returning capital to shareholders and boosting the stock price. Buybacks should be used only if other uses of capital have been optimized and the share price is undervalued. Sometimes it’s obvious that the buybacks are excessive. Sometimes it’s not. I would look for if the board has adopted a capital allocation framework. It brings capital allocation discipline. It should be part of a broader long-term strategy. And look at past decisions to see if it’s been respected and their impact. It should give you enough clues on whether they are disciplined or wasteful.
But as I mentioned, the problem is not the tool, it’s a governance issue. Directors should fulfill their fiduciary duty and focus on the economics. When buybacks are misused, it’s a loss for society because all the stakeholder loses.
