Share buybacks are a short-term tool — 7IM Short Thoughts

I talked a lot about dividends recently, and dividends are a great way for companies to reward shareholders - give them a slice of the profits. The problem is, though, that they're a bit like Pringles: once you pop, you can't stop. Companies need to keep paying them; otherwise, investors lose confidence. An alternative to dividends is share buybacks. Great for one-off occasions where a company makes a load of money selling an asset or something, go into the market, buy a load of your own shares, and then cancel them.

What that means is the remaining shareholders are left with a larger slice of the pie. Everyone wins. The thing is though, in the US over the last two decades, companies have more and more been doing share buybacks rather than paying dividends. It's no longer a one-off thing. Why is that? Well, there are some reasons like tax that explain it a little bit.

But one of the prevailing theories is that, as compensation has increasingly tilted towards rewarding senior employees with shares, they got more incentive to buy their shares back rather than pay a dividend. A great example of how this can go wrong is Bed, Bath & Beyond. Between 2014 and 2022, Bed Bath & Beyond had $6bn of cash lying around, but it bought back $5.6bn of its own shares, leaving only $400m to invest in the business.

It's no wonder in 2023, Bed, Bath & Beyond went bust. The share price had been propped up, but the business wasn't being supported. It's a great reminder that any investment that relies on buybacks to keep making money is not the same as a good investment.