The Viewpoint – To buyback or not buyback: price is the question

Understanding the ways a business intends to allocate its capital is one of the most important parts of active investing. A company’s choice between investing for growth or giving cash back to shareholders is a major determinant of future returns.  

As part of this debate, share buybacks tend to be presented as the cleanest, most shareholder friendly use of capital. They are flexible, tax efficient, and accretive – at least in theory. But before examining where this logic breaks down, it is worth acknowledging why buybacks have become so popular in the first place.

On the surface, the maths looks compelling. A dollar spent repurchasing shares reduces the share count, leaving every remaining shareholder owning a slightly larger slice of the business and mechanically lifting earnings per share. Unlike dividends, buybacks are viewed as more tax efficient for many investors, and more flexible for management as cash can be returned without committing to a recurring payout.

Framed this way, a buyback can appear superior to a dividend. It is precisely this framing, however, that obscures the real economic trade-offs involved.

Sometimes capital allocation choices that seem shareholder friendly can actually work against long-term owners. Chris Bloomstran, the head of US investment boutique Semper Augustus has been drawing attention to this issue for many years. His work has been particularly effective in reframing buybacks as a decision that depends on price, opportunity cost, and context. In his most recent letter, which I would strongly recommend anyone to read, he brings this tension into focus:

“Despite an enormous proportion of cash flows from operations being spent on share repurchases, the overall [S&P 500] share count is now higher by 3.3% since June 2020 and down only 2.5% cumulatively over the past decade. It’s shocking that since the turn of the century the share count is 1.8% higher despite massive giveaways to insiders”.

“Share reduction of the index companies was a modest 0.3% per annum for the past decade. Said differently, index companies spent roughly two-thirds of profits purchasing 2.7% of their market capitalization each year, yet only reduced the share count by 0.3% annually. Retained earnings for the index are NOT reinvested at the return on equity but are spent repurchasing expensive shares.”

In other words, despite the scale of share repurchases over the past few decades, the outcome has been underwhelming. What makes this dynamic particularly problematic is that a large proportion of buybacks are not undertaken to increase shareholders’ ownership of a business at all, but simply to prevent it from shrinking This is because stock-based compensation has all but wiped out the effects of buybacks. This form of employee reward is a growing call on corporate cash flows, particularly in capital-light and technology-enabled industries.

Despite the scale of share repurchases over the past few decades, the outcome has been underwhelming.

From a shareholder’s perspective, this materially changes the calculus. Capital that might otherwise have been reinvested at attractive returns, paid out as a dividend, or preserved for future opportunity is instead used to stand still. It masks the underlying transfer of value from shareholders to insiders while leaving headline per share metrics superficially intact.

That distinction matters because long-term shareholder returns are ultimately driven by the return earned on incremental capital. Buying back shares at elevated prices essentially locks in a low forward return – the inverse of the multiple paid – regardless of how attractive the underlying business may be. At today’s market levels, that return is often materially lower than the amount companies can earn by reinvesting internally. In many cases it is also lower than what shareholders could achieve by investing this money themselves.

Again, Bloomstran puts this plainly: “Repurchasing shares at high prices destroys capital. Shares bought at today’s 26x P/E earn 3.9% for shareholders, not the index’s 20% return on equity that one might expect.” The distinction is crucial. Return on existing equity tells you something about the quality of the business. Return on incremental capital tells you whether growth, buybacks, or dividends make sense from here.

The irony is that buybacks tend to be most aggressive when they should be least so. When confidence is high – cash flows are abundant and valuations are stretched – repurchase programmes expand. When valuations compress and expected returns rise – precisely when buybacks would be most accretive – companies tend to pull back in the name of prudence and balance sheet protection. We can see this in the chart below, which demonstrates big drops in buybacks during the pandemic and the Global Financial Crisis, followed by a rapid rebound when markets recovered.

Source: Standard & Poor’s; Semper Augustus

The result is a pro cyclical pattern: buying fewer shares at low prices and more at high prices. Not great for long-term shareholders – although fortunately there are some shrewd outliers.

When assessing companies using our own Corporate Life Cycle framework we see resilient companies as those that align their investments and distributions with their Life Cycle reality. Younger or mid-life businesses with genuine reinvestment opportunities should prioritise growth and resilience rather than financial engineering. As these companies start to mature and returns trend downwards, capital returns should become more of a priority. In those cases, a sustainable dividend can impose exactly the right constraint, forcing management to compete honestly for capital and reducing the temptation to overpay for their own shares simply because the cash is available.

Porfolio characteristics and holdings are subject to change without notice. This does not constitute an investment recommendation. For illustrative purposes only.

As an income investor, it might seem intuitive that I’m arguing the case for dividends versus buybacks.  However, none of this is an argument against buybacks per se. When shares trade well below intrinsic value, buybacks can be the highest return investment that a company can make. This is the case for the most interesting Turnaround opportunities that we come across, albeit examples are rare. Most of the time, particularly late in the cycle, the choice is more complex and riddled with disincentives.

Good capital allocation is ultimately about humility. Managers need to recognise when the best use of capital is inside the business, when it is better handed back to shareholders, and when restraint is the most valuable decision of all. Buybacks are a tool that, when used carelessly, can quietly erode long-term shareholder wealth. But when used selectively, at the right price, can enhance it significantly.

Dividends, by contrast, are often underappreciated precisely because they impose discipline rather than promise ‘growth’ or ‘optimisation’. This forces an honest assessment of opportunity cost, transferring agency back to shareholders, and providing a repeatable contribution to long-term returns.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. Reference to any security is for information purposes only and should not be considered a recommendation to buy or sell.

The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties. Actual outcomes may be materially different from those expressed or implied.