On Buybacks versus Dividends (prompted by the occasion of Microsoft's huge special dividend):
To stock traders, the buyback makes perfect sense. If you buy stock in the open market, you help maintain the stock price. If you buy back shares of stock, you reduce the number of shares outstanding, which in turn increases the earnings per share.
This of course is completely contrary to every message that every company CEO, particularly Microsoft tries to send, that they are not trying to manage earnings or the stock price.
More importantly, it rewards the exact thing that should not be rewarded. It rewards people getting out of their investment, while not rewarding keeping the investment.
Sell the stock, you get paid. Keep the stock, you get nothing. Yes, I know that the stock price is supposed to go up for those who keep it, but there are no assurances that it will. The only certainty is that the seller has cash in the bank. The holder has the same amount of risk.
Shouldn't continuing shareholders be rewarded rather than the sellers?
That's why I am such a big fan of dividends. Dividends are the investors' best friend for several reasons:
1. The obvious, it's cash in the bank
2. It reduces your cost basis and rewards you for being a continuing shareholder
3. It can put a cap on how much the company can dilute your holdings. When a company pays a dividend, it's much more expensive just to issue stock and options to insiders. They have to consider the cash implications of each additional share or option issued. That's a good thing. It keeps companies with legitimate dividends from going nuts.
4. It creates a precedent of rewarding shareholders, hopefully with increasing dividends.
On the flipside, share buybacks are horrid for several reasons
1. It allows companies to manipulate earnings per share. Buy back enough stock, and you will hit your Wall Street expectations.
2. Companies will undertake risky cash management strategies to pay for the share buybacks. Since its one time, they can take greater risks
3. Companies will undertake buybacks with CEO and management incentives and bonuses in mind. Hit those numbers, earn lots of stock and options.
4. Companies will buyback stock so that they can re-issue it to themselves and employees. In essence they use the market as their personal and corporate piggybanks. They Buyback stock to push up earnings in hopes the stock goes up. Then they issue the stock to themselves. Then if the stock goes up, they sell the stock they awarded themselves to unsuspecting shareholders who have no idea the money they are paying for shares is going to insiders.
Stock buybacks are a very bad idea for investors and a very profitable idea for insiders and traders.