Warren Buffett is all for returning cash to shareholders. But the legendary investor has long preferred to do it through stock buybacks rather than dividend payments.
Stock buybacks—whereby a company repurchases its own stock to reduce the number of outstanding shares on the market and thus enhance the value of the shares that remain—are essentially an artificial way for companies to drive up their own stock price to improve their earnings per share.
Buybacks have worked for Berkshire Hathaway (BRK-B), Buffett’s multinational holding company; the stock has risen 28.5% per year on average in the 20 years since its “B” shares came public despite never paying a dividend. Stock buybacks have no doubt played a major role in Berkshire’s success.
But do they work for every company? Evidence is mounting that they don’t—and it’s certainly not due to a lack of effort.
Non-financial companies alone have repurchased $1.3 trillion of their own shares over the past three years. Since 2010, the cumulative number of shares outstanding among S&P 500 companies has declined by nearly 4%. Given the returns in the S&P 500 during those time periods—9.5% annually over the past three years, nearly 13% since the start of 2010—it’s hard to argue against the buyback strategy.
Lately, however, buybacks don’t seem to be moving the needle much.
Here’s a list of the 10 companies that spent the most money on stock buybacks in 2015, and the returns in their share prices in 2015.
Apple (AAPL)
Money spent on buybacks: $50 billion
2015 return: -4.6%
General Electric (GE)
Money spent on buybacks: $50 billion
2015 return: 23.3%
Walmart (WMT)
Money spent on buybacks: $20 billion
2015 return: -28.6%
Home Depot (HD)
Money spent on buybacks: $18 billion
2015 return: 26%
Qualcomm (QCOM)
Money spent on buybacks: $15 billion
2015 return: -32.8%
Gilead Sciences (GILD)
Money spent on buybacks: $15 billion
2015 return: 7.4%
United Technologies (UTX)
Money spent on buybacks: $12 billion
2015 return: -16.5%
PepsiCo (PEP)
Money spent on buybacks: $12 billion
2015 return: 5.7%
American Express (AXP)
Money spent on buybacks: $11.9 billion
2015 return: -25.3%
Goldman Sachs (GS)
Money spent on buybacks: $10.8 billion
2015 return: -7%
There are some notable exceptions in there, of course. Stock buybacks seemed to work quite well for Home Depot and General Electric. Gilead Sciences and PepsiCo also posted nice returns considering the market was essentially flat in 2015. But 2015 represented GILD’s smallest annual return since 2010, and PEP’s smallest return since 2012.
All told, the average return last year for the companies that spent the most buying back their own stocks was -5.2%, well below the -0.7% return in the S&P 500 in 2015. That doesn’t exactly scream money well spent.
On the flip side, the 10 companies that spent the most on dividends in 2015 collectively outperformed the market, up an average of 0.7% for the year. That’s impressive considering two of the biggest dividend payers were big-oil companies Exxon (XOM) and Chevron (CVX), both of which were down double digits along with just about every other energy stock in this low-oil-price environment.
Interestingly, the best performer among the largest dividend payers was GE, which could suggest that it was the generous dividend (3.1% yield) that was driving the stock, not the record-tying buybacks.
Speaking of yields, all of the above returns were share-price appreciation only, not total return, which would incorporate the yield. Tack those on (3.1% for GE, 2.8% for Microsoft (MSFT), another top-10 dividend payer that performed well), and the performance was even more impressive.
My point isn’t to denigrate Mr. Buffett’s long-held theory on stock buybacks. Long term, the numbers actually support his theory. But even he admits that buybacks have gotten out of hand.
The problem, according to Buffett, is that activist investors are pushing companies to do buybacks that don’t make economic sense—mainly because buybacks have helped juice share prices in the past.
As our Roy Ward wrote in a recent issue of the Cabot Benjamin Graham Value Investor advisory, “Buybacks are a great way to increase earnings per share for the benefit of top executives’ stock option plans. But believe executives should be investing those funds in creating new products, increasing productivity, and hiring and educating higher quality employees.
“Stock buybacks and distributions,” Roy continued, “are not the best use of corporate funds because they do not contribute to the company’s growth—rather, management should use the funds to increase sales and revenues and expand their companies.”
Apple, for example, spent more than any other company on stock buybacks and dividend payouts in 2015, and yet the stock went nowhere in large part because Apple’s products have grown stale. The latest iPhone no longer excites investors; they want something new from Apple—that is, if they’re not too busy fighting FBI court orders (sorry, had to get that in there).
Buybacks can work for the right company (see Home Depot). But they’re not for everybody. And right now, just about everybody is trying them. For companies such as Apple, Walmart and American Express, the billions of dollar spent on buybacks last year was wasted money.
There are a number of valid reasons to buy a stock—strong earnings and revenue growth, revolutionary or game-changing products, a long history of dividend growth. Huge share repurchase programs used to be another big selling point. Maybe they shouldn’t be anymore.
At the very least, don’t let a buyback be the thing that convinces you to invest in a stock.
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