Billionaire Cliff Asness, the guru of mathematical investing and quantitative genius who founded AQR Capital Management, had some thoughts on stock buybacks last week. “Is there any financial topic that people say more silly things about than buybacks?” he asked on Twitter. “Everyone is deranged about buybacks.”
Asness is correct, and unfortunately, the current stock-buyback debate is more than a simple disagreement between billionaire portfolio managers. Underneath the gross misperceptions of the anti-buyback crowd is a dangerous left-wing ideology whose message is gaining traction with an unsuspecting audience.
From a professional standpoint, there is an irony in my coming to the defense of stock buybacks. I run a wealth-management firm whose nuanced investment philosophy specifically centers around the return of cash to shareholders via dividends, a use of cash often said to be at odds with stock buybacks. And indeed, I would defend in as many pages as allotted (and have done just that) the superiority of dividend growth to stock buybacks as a shareholder-friendly, management-/investor-aligned use of cash. But that is beside the point of the current discussion, which is to correct the anti-buyback faction’s misunderstanding of free markets so as to defend them.
Last week, The Atlantic published a piece by Annie Lowrey entitled “Are Stock Buybacks Starving the Economy?” You will be shocked to learn that the interrogative nature of the title was somewhat disingenuous. The article is a strong declarative case for the belief that stock buybacks are at odds with the best interests of workers and represent a contractionary use of funds in the overall economy. As is almost always the case with left-wing economic arguments, there may very well be some good intentions somewhere at the root of Lowrey’s message, but it fundamentally misunderstands some of the most basic economic truisms.
To complain that buybacks use up money that could be spent on other company expenses is essentially to argue against profits themselves, because buybacks are effected with the cash generated from a company’s profits.
The piece starts with a classic zero-sum fallacy: the idea that stock buybacks are “pulling money away from employee compensation, research and development, and other corporate priorities — with potentially sweeping effects on business dynamism, income and wealth inequality, working-class economic stagnation, and the country’s growth rate.” It quickly moves toward blaming buybacks for sluggish economic growth, low productivity, and piddling increases in worker compensation. And then it adds in some good old-fashioned class envy, moaning that “companies are working overtime to make their owners richer in the short term, more so than to improve their longer-term competitiveness or to invest in their workers.”
The first step to understanding buybacks is understanding where the cash that funds them comes from. Once that’s done, it may behoove one to understand what buybacks are used for, and what exactly they do to a company’s balance sheet. To complain that buybacks use up money that could be spent on other company expenses is essentially to argue against profits themselves, because buybacks are effected with the cash generated from a company’s profits. Buybacks are not a company expense; they are a use of cash from company profits — from the money that remains after expenses are deducted from revenue. So a company can be criticized for pocketing as profits money that could be spent on expenses such as R&D, or for using its profits to buy back shares rather than paying them out in dividends or saving them for the future. But the positioning of share buybacks as a competitor to other company expenses is ignorant at best, and flat-out dishonest at worst.
The Lowrey article chooses to focus on the alleged crowding out of wage growth that stock buybacks create, and borrows heavily on the claim that workers could have been paid more in a world of fewer stock buybacks. There is a mathematical truth to the argument that more wages could mean less profits and less profits could mean more wages. It is also unhelpful to the present discussion. The question ought to be: What drives value for the stakeholders of the company, building the incentive to create jobs, grow wages, and increase economic productivity that serves as the engine of free enterprise? Attacks on profits themselves, if successful, shrink the pool of money from which wages are paid out.
Indeed, contra the arguments of Lowrey and her ilk, stock buybacks happen to be the very source of tremendous “wage growth” for employees. The effect of stock grants to employees over the last 20 years has been unprecedented balance-sheet wealth for mid-level programmers, administrators, sales people, designers, and others. Try convincing employees of Apple that their annual stock grants do not count as wage growth! Where do the shares of stock come from that are used in restricted-stock grants and stock-option plans? From shares the company has purchased in buybacks!
The war on stock buybacks is, at its root, a war against capital formation, in the name of defending laborers. The false dilemma at the root of this argument reflects buyback critics’ painful ignorance of the workings of free markets. For if one believes that stock buybacks are made at the expense of research, opportunistic acquisitions, training, equipment, and worker wages, then he believes that those driving stock buybacks are seeking to undermine the very profits that pay for them.
As a professional investment manager, I find dividends to be a more investor-friendly way to reward shareholders, giving them positive cash flow and allowing them to realize monetization of their investment periodically, as opposed to constantly compounding the risk of a given holding. But that is an argument for how a corporate board should allocate the capital the company has generated via company profits, not an argument against profits themselves.
The idea that share buybacks starve access to new investment is absurd on its face. A company balance sheet with more equity (higher earnings-per-share) has that much more buying power and that much more borrowing power in the open market. Investors will seek the most efficient capital allocation they can find, and companies seeking to attract new investment will respond to that pursuit. Again, no real-life assessment could ever conclude that companies generating growing profits and using said cash flow to reduce share count (value creation) are cutting off their access to purchasing power. That binary thinking lacks awareness of balance-sheet management and profit-and-loss management.