Stock buybacks are bad: Further evidence

Reading time: 3 – 4 minutes

In the working paper “The Buyback Monitor – July 2009: Corporate Stock Buyback Profits of 273 Firms from 2000 into 2009“, published on the Social Sciences Research Network, M.A. Gumport, CFA, provides further evidence that stock buybacks are not as good for investors as often touted.

Wall Street has favored buybacks for years ...

The following is quoted from the abstract of this research paper:

Few purely financial decisions rival stock repurchase programs in their bearing on the well-being of shareholders. Absent better financial reports on buybacks, an occasional tally of results seems appropriate.

The current “Monitor” extends an earlier study back to 2000 to look at profitability of $263 billion of buybacks executed by a sample of 273 corporations, largely in the technology sector, with total equity market value of $655 billion. 66% of sampled companies engaged in buybacks.

While this studies’ reporting methodology tends to significantly overstate buyback profitability, only 25% of buyback programs are currently reported to be profitable.

The average sampled company that engaged in buybacks paid out 43% of its current equity market value to buy shares that subsequently declined in value by 19.7%.

Had buybacks not been executed, share prices for these companies now would be at least 8.4% higher (or, after adjustment for bias in methodology, more than 13% higher).

Buybacks are undesirable

This study provides evidence on the company level that stock buybacks — exempted from normal legal sanctions for stock manipulation since 1983 by SEC Rule 10b-18 — are not as beneficial to investors seeking short-term capital gains as usually claimed.

The proponents of stock buybacks have long argued that capital gains are better for investor than dividends.

Without stock buybacks, cash dividends could have been much higher over the last generation, which would have contributed far more to investor wealth than unrealized, fleeting capital gains.

The wisdom of dividends

Until the 1960s, dividend yields on US equities usually surpassed bond yields. From the 1980s onwards, capital gains became the goal and dividends faded in importance.

In the article section, The Wisdom of Dividends, there is an analysis showing that over the long run, if the former practice of favoring dividends over capital gains had persisted over the last three generations, investors would be much better off today.

Misguided regulation and taxation

However, the SEC continues to sanction and encourage equity buybacks, and to allow misleading total return statistics to distort mutual fund reporting.

The government imposes double taxation on cash dividends and the Obama administration is proposing even higher taxation of dividends in order to pay for various “spending is stimulus” programs and nationalized healthcare.

M.A. Gumport’s recent research paper on the effect of buybacks on stock prices contributes to the growing body of evidence against stock buybacks that, eventually, may influence government policy and investor opinion.