For Democrat Senator Elisabeth Warren, the case is clear: companies buying their own shares in the market do wrong. They are manipulators, hiking share prices artificially, thereby enriching their shareholders instead of putting money to better use, like paying higher salaries, for instance. Now, as an investor, I’d appreciate higher share prices, as I appreciate solid, regular dividend payments. I would be less happy about permanently rising salaries. But then, I am not a politician. When it comes to share-buybacks though, I am not sure that shareholders will profit.

Arithmetically speaking, it should not matter for shareholders whether they’d received their reward in form of dividends, or via share buybacks. When a company spends its earnings to buy its own stock on the market and then cancels the acquired shares, profits per share will increase, thus making its stock more valuable, as a larger part of profits can now be attributed to each of the fewer share owners. The “intrinsic” value of each share will rise accordingly, making each investor richer.

For a company, with its aim to maximise shareholder value, dividends are a perennial burden. They have to be kept steady and keep rising over time. If they are meagrely forthcoming, the stock will be less popular. To reduce or cancel a dividend in times of financial need will have dire consequences for the stock price ‒ proof that a company has fallen on hard times. Share buybacks are singular events. In times of superfluous cash, it can be handed to shareholders without raising their expectations of future handouts. Nobody will dump a stock if buybacks are not forthcoming.

A further bonus lies in the habitually different taxation of capital gains and dividends: companies pay corporate tax on their earnings before paying them out as dividends. Dividend receivers then pay income tax on their dividends received. Both forms of taxation can be avoided when corporate expenditure boosts the share price. For retail investors, share buybacks have the additional advantage of avoiding withheld dividend taxes and the headache that comes with reinvesting often tiny amounts.

Famed investor Warren Buffett, who runs Berkshire Hathaway, one of the most successful investment vehicles on earth, has never paid any dividends to its shareholders, while allocating sizable amounts of Berkshire’s ever rising cash mountain to share buybacks. He spent $9.2 billion for share buybacks last year, and $27 billion in 2021.

These are astronomical amounts, yet tiny when compared to the pile of cash not invested, which stood at $168 billion at the end of 2023. The value of Berkshire stock has dutifully more than doubled in two years.

For Buffett, the indiscriminate vilification of buybacks smacks of financial illiteracy.

Broadly speaking, both the critique of, as well as the justification for share buybacks focus on the question of future earnings. If a company is well run and offers a competitive product, why not invest idle money in research and development, in more advanced production facilities, in better marketing, or workers’ training?

On the other hand, if a company has matured beyond fast growth and can merely be expected to continue doing more of the old same (think tobacco), better to return capital to shareholders who then have a choice to put their money elsewhere.

For Buffett, the indiscriminate vilification of buybacks smacks of financial illiteracy- Andreas Weitzer

Share buybacks are thus either proof that management has, rightly, limited hope for further growth and thus acts responsibly by returning money. Or they are evidence that management is clueless and is gambling away their company’s future with underinvestment. Investors’ opinions will be divided.

Should Big Oil, for instance, invest in new upstream operations, or rather in new technologies, or should its vast earnings, boosted by rising oil prices, be better distributed to its shareholders?

Warren, the leftish firebrand, had made another valuable point. BAE, the British aerospace and defence company, was recently awarded a substantial subsidy under Biden’s 2022 CHIPS and Science Act, while it continued a sizable share buyback programme. Should the US tax payer subsidise a foreign company that takes the subsidies and doles it out to shareholders, instead of investing them?

It is also important to note that share buybacks are not always reducing the share count. Many companies keep the shares they have acquired on the books.

They spend the money they have earned without benefitting shareholders.

This is mainly due to two reasons. They (1) either use their own shares for the acquisition of companies. This may or may not be beneficial to shareholders. Many takeovers are vanity projects of overly ambitious CEOs. Mergers and acquisitions often add little to a firm’s profitability, or may typically end in losses. Think of Bayer snatching up Monsanto, the weedkiller company, or Mecedes Benz buying Chrysler.

Or they (2) use the purchased shares to gratify management with a stock bonus. If they cancel them, it is only to avoid dilution from share options handed out to employees earlier. This reward of insiders comes at an unfair cost to existing shareholders. This is made worse by hiding the true expenditure for labour with “free” share options.

A case in point is the agent problem of managing directors. Their performance-linked bonuses are often measured as “profits per share”, or awarded for share price growth. Spending a lot of company money for share buybacks thus translates into higher pay for directors, who will authorise share purchases solely with the aim of boosting their salary. This is harmful to shareholders whose profits are diverted to management. And doubly harmful when shares are bought irrespective of their actual price.

Instead of buying presumably undervalued stock, shares are bought at their peak. Instead of enjoying a gradual appreciation, stock owners will see their shares deflate. Profits that could have been put to better use, will be wasted.

My opinion about this is divided. In all my years as a retail investor I have had a hard time to observe the math of the share-price-boosting effects of buybacks. Shares, I found, are much more dependent to market moves than buyback appreciation. If I had a say, I’d prefer special, one-off dividends to the hard-to-pin-down math of share buybacks. Better the sparrow in the hand, than the pigeon on the roof.

That said, executed in a planned, responsible way, the logic of buybacks should work. See Berkshire Hathaway. But sadly, not every CEO is a Warren Buffett.