Amid the impending government stimulus, the issue of stock repurchases has once again hit the headlines. Buybacks are often framed as the poster child of corporate greed or lapses in governance, designed to line executive pockets and enrich existing shareholders at the expense of broader long-term value creation. But the first critical point to remember is that buybacks should be a distribution of profits that remain after all constituents have been taken care of, and they should not be done at the expense of any stakeholder, including employees.
Let’s assume that the buybacks we have seen have been made with good intentions and examine what influenced the decision making. Stock repurchases are one of five capital allocation tools available to public companies, along with business reinvestment, acquisitions, dividends, and debt reduction. Like any other capital allocation decision, there are times when buybacks make sense, and times when they don’t. How, why, and when management teams take these actions matters greatly. Skilled capital allocation separates well-run companies from their peers, and this period will be no different.
The second point is that suboptimal capital allocation decisions are nothing new. Profits increase during good economic periods, and the resulting cash rarely sits long with the company; it is usually invested or distributed soon after profits are realized. Historically — and still today in some industries — cash has tended to flow toward expanding company assets: building new mills or mines, laying more fiber-optic cable, acquiring land, and many other examples. These have sometimes been poor decisions, sowing the seeds of oversupply, creating painful periods during cyclical downturns, and leaving companies short of cash when they need it most.
Over the past decade, corporations seemed less willing to build ever-greater capacity, possibly because of the scars from the global financial crisis. Cash piled up, and buybacks became a popular outlet for spending it. Some prices paid look poor in retrospect, making owners question those decisions. But I think investors should look in the mirror.
Collectively, we have pushed corporations to optimize everything, from cost structure to capital structure, leaving no spare dollar lying around. If a management team deviated from that norm in recent years, the board or CEO could expect a call from an activist. Large distributions in the form of buybacks naturally followed, seen as easier to flex and more tax efficient than dividends. Might business owners (that is, shareholders) be better off if companies had a chance to be opportunistic — which could mean sitting idle for an extended period and letting cash balances increase? Unfortunately, I believe many investors would contest such a practice.
My overall point is this: Capital allocation is a critical and differentiating skill for management teams. This period will once again demonstrate that. Companies that make good capital allocation decisions — including stock repurchases — while still considering all constituents are the rare gems that I prefer to invest in. I invest with an owner mentality and decades-long time horizon. To me, it’s common sense that a business that helps all its stakeholders succeed can thrive long term. I believe that, as investors, we should support and hold companies accountable for doing right by their stakeholders, and we should do so in a thoughtful, case-by-case manner. We could, for example, back compensation plans with long horizons that give management time to be patient with capital. In my view, creating an environment supportive of successful capital allocation helps all market participants and society at large.