Early Investing

Buybacks Are Bad for Shareholders

Buybacks Are Bad for Shareholders

My old nemesis SoftBank was in the news today. Thanks to some big bets paying off in its $100 billion Vision Fund, it posted a record $46 billion profit for the last fiscal year.

I’m not impressed. In fact, I’ve never been a big fan of SoftBank’s Vision Fund. I’ve written a lot about why I don’t like the fund’s investing philosophy (click here and here to read some of my past articles).

And now I have a new reason to dislike SoftBank even more. In the face of flat income growth — it was actually in the red for 2020 — the company resorted to a huge buyback program. It bought some $23 billion of its own shares back. And because of that, SoftBank’s stock price rose 43% over the past 12 months.

To tell you how buybacks work, I need to explain earnings per share (EPS) first. It’s a key metric used to evaluate a company’s performance. EPS is the company’s net income divided by its total number of outstanding shares. EPS goes up when net income rises. It can also go up when the number of shares decreases. Because buybacks reduce the number of outstanding shares, they’re a quick and easy way to artificially push EPS up. 

Buybacks Are a Sign of Stagnant Growth

Companies have three basic choices for how to use their cash. 

  • They can reinvest it back into themselves to stimulate growth — which is what companies with healthy growth prospects do. 
  • They can give it back to shareholders in the form of a dividend. This is often the choice of slow/no-growth companies. 
  • Or they can use it to buy back their own shares as a “riskless” way to push up EPS and drive demand for their shares when income is flat. 

A company unwilling to invest in its own growth is a company that will eventually stop growing. Using buybacks to inflate stock prices is not sustainable.

Nor is it capital efficient. The Nasdaq is currently at or near the most expensive levels seen in recent history. Companies engaging in buybacks are going after very high-priced shares. Buying back shares when they’re cheap is one thing. Buying them at these inflated prices is short-term thinking at its worst. 

Companies are also inviting risk through buybacks. It’s not a matter of if but when. 

A couple of bad consecutive quarters would bring their share prices back to earth and shrink their cash reserves. If companies are determined to do buybacks, they should initiate them when shares are crashing. That way they’re able to buy back more shares with less money. That’s a much more tolerable approach to buybacks.

But alas, scores of companies are set to follow SoftBank’s example. U.S. companies announced $484 billion in share buybacks in the first four months of this year. According to Goldman Sachs, it’s the highest total in at least two decades. And the firm projects that share buybacks by companies will increase 35% from 2020 to this year. 

Shareholders Suffer

Companies claim their buyback programs are a great way to reward shareholders. Higher share prices benefit investors in a very real and direct way, they say. 

What they don’t say is buybacks reward CEOs and C-suite executives even more. They get huge bonuses for achieving higher share prices. Many also get bonuses for achieving higher earnings per share. And as I just illustrated, EPS is easy to manipulate.

Buybacks favor the immediate term at the expense of the long term. I view them as self-interested, bearish and dangerously risky. The CEOs who approve them show little faith in the company’s ability to grow at a pace that would impress investors and spur demand for its shares. 

I’m not particularly surprised that SoftBank committed to the move. But it makes me nervous that Apple, Amazon, Alphabet, JPMorgan and a host of other companies are following suit. 

CEOs are gaming the system. They are using buybacks to conjure financial rewards without any real commitment to growing the company. Shareholders are, in effect, investing in fake growth. 

If I were you, I’d take the money and run. Or better yet, put it in startups. They offer real high growth investment opportunities. And startups mostly stay away from buybacks. Every now and then, I’ll see a company promoting a form of buyback as part of an offering. But they’re outliers. And that should continue to be the case. 

Today’s “buyback bonanza” will be tomorrow’s day of reckoning. CEOs will have banked their big bonuses. And as usual with market manipulation, it’s the shareholders who will suffer the most. 

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