Lies, Damned Lies, and Statistics

Are stock buybacks really good for shareholders?

Chevron announced they plan to buy back $75 billion of their shares in stock buybacks, and they're not the only ones. More than 50% of S&P companies engage in this practice. That’s quadrupled since 2010.

What does a stock buyback mean? Is it good for shareholders? Is it good for anyone?

When companies have extra cash that they don’t know what to do with, one of the things they can do with it is buy shares of their own stock on the open market and then retire those shares. Taking the shares out of circulation reduces the total number of shares, which makes each remaining share worth a little more.

Theoretically, this is good for shareholders. It’s kind of like getting paid a dividend, because you still own shares, but each share you own is worth a greater percentage of the overall company pie.

But why not just go ahead and pay out a dividend directly to shareholders rather than buy back shares?

One reason that a shareholder might like a stock buyback over a dividend is because a dividend is a taxable event. A share buyback increases the value of your shares, but you don’t get taxed on that increased value until you sell the shares.

So far, so good, right? Well, the trouble is that just as companies can “retire” shares, they can also create new shares. Most people don’t realize that a company’s stock is kind of like its own private currency. Just like the Federal Reserve can print and burn dollars, companies can print and burn their own stock.

Many companies shout from the rooftops about their stock buybacks and retiring shares but are often quiet as a mouse when it comes to the creation of new shares out of thin air – and they do create new shares out of thin air. For the most part, these newly minted shares go to employees and managers.

Getting back to Chevron, in 2022 they spent $11.3B in stock buybacks but also issued $5.8B in new shares for employee stock option plans. So over 50% of the stock buybacks were watered down by new shares issued to employees and managers.

Another benefit to management from share buybacks is that it reduces the amount of dividends that a company has to pay out. Dividends are paid out per share. If there are fewer shares outstanding, there are fewer dividends that need to be paid out.

Given a choice, I’ll generally take a dividend over a stock buyback. Sure, I’ll get taxed on the dividend income, but I’d rather trust myself to know what to do with that money than trust today’s management teams.

There are exceptional management teams that really do use stock buybacks for the benefit of shareholders, but they are generally the exception and not the rule. As with most everything in life and investing, you’ve got to dig a little deeper to understand what’s really happening on a case-by-case basis.

As Mark Twain famously said, “There are three kinds of lies: lies, damned lies, and statistics.”

Fight the noise,
Dr. Richard Smith

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