Share buybacks versus dividends: No contest

Dave Gilreath: ©Sheaff Brock Investment Advisors

When reading advisor commentary or watching financial TV channels, it’s not unusual to see corporate stock buybacks portrayed as highly positive events for shareholders.

Buybacks, aka share repurchases, are when corporations buy outstanding shares of their own stock.

This prevalence of this practice globally has increased dramatically over the last few decades. In the U.S., corporate expenditures for buybacks have grown at an increasing rate in in recent years, and hit a record level of $942.5 billion in 2024, up from $795.2 billion in 2023.

This is a far cry from the first half of the 20^th century, when buybacks were illegal, as regulators deemed them a form of stock manipulation. Corporate directors today would strenuously object, but a generic manipulation argument could still be made, despite the change in legal status.

Buybacks are often illogically equated with dividends—the direct distribution of profits to shareholders in cash on a periodic basis at the discretion of corporate boards.

Bird in the bush

By contrast, though buybacks usually push company stock prices up briefly, there are no payments to shareholders. So equating them with dividends is like saying that a bird briefly in the bush is the same as one in the hand.

And unbeknownst to many individual investors, the bird in the bush can be an illusion.

While board decisions to pay dividends usually reflect good recent financial metrics, buybacks are a way for companies to artificially increase earnings growth. Dividends usually reflect virtue, while buybacks are disingenuously virtue signaling.

Despite this obvious substantive difference, CEOs announcing buybacks often conflate them with dividends.

This was the case March 26, when Cognizant CEO Ravi Kumar S, in proudly discussing the tech company’s plans for share buybacks in a media interview, said without qualification that this year the company “will return $1.7 billion to investors.”

Return? Really? Actually, that would be the case with dividends, but not with a buyback.

Sure, by taking shares off the market, buybacks usually have the effect of increasing the value of outstanding shares. But calling a share buyback a “return” to shareholders is a stretch. Shareholders peering at their brokerage accounts online looking for a direct return from the company would get blurred vision waiting for Godot.

Generally, the reality is that buybacks tend to benefit corporate executives more than the shareholders who own the company. That’s because, at many companies, too much of executives’ compensation is directly linked to the short- and mid-term growth of stock prices, as opposed to long-term corporate growth. Buybacks are a reliable way to boost share prices over the short term, increasing payouts to executives.

So, depending on timing, buyback decisions by boards chaired by CEOs—and that’s the case with most companies—involve a conflict of interest when the CEO is seeking to hit stock-price targets to enhance payouts. That’s one reason why some progressive companies have non-executive board chairmen, by charter.

Financial media aren’t inclined to clear up widespread investor confusion over buybacks. Instead, they increase it by almost universally portraying buybacks as being the greatest thing since sliced bread. Never mind that many announced buybacks aren’t completed—lapses that are questionable at best.

Governance bete noire

The widespread positive view of buybacks is curious in light of the corporate governance position that they are anything but supportive.

An article in the Harvard Law School Forum on Corporate Governance in 2023 explains the flimsy value case for buybacks and notes that many “investors [instead] want management to prioritize the creation of long-term shareholder value through focusing on investing and growing the business and [enhancing] its strategy rather trying to time share buybacks… The logic behind [the] dividend-like use of share buybacks suggests that if investors believe the share price is inflated, they can opt to sell their proportionate increased ownership of the company’s shares…, thereby crafting ‘synthetic’ dividend.”

That is, seeking a gain from trading, often a tricky task, instead of receiving a real dividend in cash from the company.

As the article indicates, instead of using excess cash to repurchase shares, corporate boards would serve shareholders better by investing it in their companies in ways that organically (not synthetically) benefit shareholders.

Long term, doing so would improve corporate wherewithal to pay real dividends—the kind that say e pluribus unum.

Doing buybacks is actually contrary to corporate directors’ responsibility to always act in the best interests of shareholders, known as the fiduciary duty of care.

Buybacks put large sums from corporate coffers at risk from market volatility. By contrast, paying dividends is a distribution of profits to shareholders that reduces the risk of stock ownership; this income justifies continuing to hold shares.

Depending on market pricing at the time, buybacks can have the effect of transferring wealth from shareholders to insiders. This is no small irony, as executives are supposed to be enriching shareholders in return for incentive compensation that’s appropriately linked to the degree that shareholders are enriched.

Investors can learn about corporate compensation programs designed to motivate execs in shareholders’ interests (or not) by reading company proxy statements on the Securities and Exchange Commission website. This reading can be worthwhile for stock selection, as companies that consistently and precisely link executive compensation to corporate performance tend to have better-performing stocks over time.

The illusion of benefits

The wealth transfer from shareholders to execs from buybacks occurs more or less sub rosa amid high-profile claims that shareholders benefit.

But these purported benefits are illusory because upward stock price blips from buybacks are evanescent; they can disappear in a heartbeat. Short term, many uninformed investors get an adrenaline shot, but this fades with market forces.

The only way for shareholders to get something from a buyback is to opportunistically time the sale of shares. Yet this outcome runs counter to the oft-stated directors’ goal of enhancing long-term shareholder value; former shareholders are moot as far as this platitude is concerned.

So when you hear buybacks announced, you might consider the contrary realities voiced by critics at volumes inaudible amid all the noise from company management claiming that share repurchases are good news for shareholders.

And of course, when evaluating stocks, it’s a good idea to consider, as an alternative to companies with the buyback habit, reliable dividend-paying stocks, especially those that increase these payments consistently.

Dave Sheaff Gilreath, CFP,^® is a founder and chief investment officer of Sheaff Brock Investment Advisors, a firm serving individual investors, and Innovative Portfolios,^® an institutional money management firm. Based in Indianapolis, the firms are managing assets of about $1.4 billion, as of December 31.
Investments mentioned in this article may be held by those affiliates,Innovative Portfolios’ ETFs or related persons.