Do share repurchases benefit investors?

Or do they only benefit asset managers and executives with stock options?

If you are anything like me, you buy companies you believe will provide a steady and growing source of dividend income as their well-managed businesses increase profits and distribute surplus cash to shareholders. When you receive your dividends, you can use the money to fuel your car, buy groceries, pay your rent or mortgage, or if you have your own surplus, buy more shares (not necessarily in the company that paid you the most recent dividends, you get to decide).

In companies where managers are compensation with RSU’s, stock options, stock grants etc. those managers universally want a higher share price. Asset managers want higher share prices so their assets under management (AUM’s) rise and they collect higher fees for doing nothing more than watching as their AUM’s rise in trading value. Corporate executives cash in on their stock-based compensation and, based on my review of insider filings, typically exercise their options and sell their stock. How does a higher stock price benefit you? It doesn’t unless you want to sell and when you do, your broker clips a commission.

Owning a stock is owning a share of a business. You benefit when the price to increase your share of that business falls (unless the business itself has become impaired) since you can increase your share of the underlying earnings stream at a lower cost and if the long term return on capital of the business is not impaired, you will receive more of a growing dividend stream. Canadian bank stocks are a great example - they have turned in consistent double digit returns on capital for decades and anytime you had the chance to buy shares of the “big five” Canadian banks at or close to book value, you enjoyed steadily growing dividend income for years thereafter.

I invest in resource stocks. Their management teams are expert in petroleum engineering or geology or a related field but few of them are valuation experts. I don’t need or want them to be making “buy” decisions on my behalf by buying back stock. They call it “return cash to shareholders” but in reality a stock repurchase is giving cash to people who will no longer be shareholders and taking that cash from shareholders who keep their shares. Why is that something I should want?

Share buybacks do benefit continuing shareholders if and only if the shares are repurchased at a discount to their underlying value but management teams (who are universally bullish on their companies prospects or are lying to us in shareholder meetings) are ill-qualified to make such a judgment. The efficient market hypothesis (EMH) and its derivative theories garnered a Nobel Prize for more than one laureate including Eugene Fama, Harry Markowitz, Franco Modigliana, Merton Miller and William Sharpe who all promoted the idea that the stock market generally values businesses at or close to their underlying value, and other Nobel laureates like Bob Shiller or Richard Thaler who argued “not so fast”, there are undervalued securities. I don’t think the CEO’s of the companies I hold shares in are Nobel laureates in economics or finance and I believe them ill-equipped to judge when their stock is undervalued or otherwise. In a nutshell, I would like to make that decision for myself.

For interest, my former employer McKinsey & Company, Inc. did a major study of buybacks and concluded investors would be better off if those companies used that money to increase dividends or invest in the assets of their businesses.

I like the assets of MEG Energy, for example, but I see no benefit in CEO Derek Evans (whose copy book is stained with the failure of Pengrowth Energy while he was CEO) touting share buybacks as a good use of free cash flows. Just pay down debt, pay dividends and increase investment in the excellent SAGD assets of MEG and we will all be better off. Well, all except Mr. Evans, who may have to actually improve operating performance of MEG to earn higher compensation instead of gambling on commodity prices with my money.