FinPod

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Welcome curious minds today. We're doing a deep dive into something you hear about all the time Stock buybacks right they're constantly in the news exactly companies buying back their own shares But what does that actually mean, you know on a practical level and why do they do it? Is it smart? Is it controversial? It's Definitely one of the most debated topics in corporate finance. Yeah, you hear everything from smart capital allocation to well much harsher terms Yeah, so our mission today is really to pull back the curtain will unpack how they work why companies choose them maybe instead of dividends look at the good and Definitely look at when they go wrong We've got some real examples and we've got some great source material guiding us like sure buyback strategies and stock buybacks mechanics value and risk We want to give you that sort of aha Moment cut through the noise so you're genuinely informed sounds good. Okay, let's unpack this. Let's do it So let's start really basic when a company announces a stock buyback. What's actually happening like on the ground Okay, so at its core. It's pretty simple The company goes into the open market and buys its own shares just like any other investor could okay think of the company as a pie Right cut into slices the shares a buyback means the company removed some slices from circulation fewer slices Exactly fewer shared outstanding and assuming the pie's value stays the same or grows each remaining slice each share Becomes potentially more valuable. Okay, so fewer shares outstanding Right. How does it directly help say an investor? What's the immediate impact? Well, the big one is earnings per share or EPS. That's a metric everyone watches, right? If you divide the company's total profit by fewer shares the profit per share automatically goes up Mathematically sense and that often gives the stock price a bit of a short-term kick It can also you know impact executive pay if bonuses are tied to EPS Okay, and how do they pay for this? Where does the money come from? Usually one of three ways they might use excess cash they have sitting around Okay, they might take on new debt to fund it or you know some combination of both cash and debt Right, but you mentioned something crucial earlier opportunity cost using cash for buybacks means that cash isn't used for Other things right that is the fundamental question. Absolutely. Every dollar spent on a buyback is a dollar that could have gone into R&D Paying down debt making an acquisition expanding the business or even dividends, which is another way to return cash or increasing dividends. Exactly Yeah, so the real debate always comes down to was buying back stock The best use of that capital for the company's long-term health

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That's the crux of it. Yeah, that makes perfect sense and it leads right into that comparison Buybacks versus dividends Companies often have to choose. What are the key differences there? Why pick one lane? It's a big strategic choice dividends are usually seen as a commitment their regular predictable payments like getting a check in the mail Sort of pretty much. Yeah, they appeal to income investors and once you start paying a dividend cutting it sends a really negative signal Investors hate that. Okay, so dividends are steady a promise buybacks then More flexible. Is that the idea? That's the main advantage for management. Yes flexibility buybacks are discretionary a Company can announce a big program but then execute it slowly speed it up pause it Depending on market conditions cash flow, whatever so they're not locked in exactly They can use them opportunistically like when they think their stock is undervalued Mm-hmm, or just when they have a pile of cash and maybe not enough great internal projects to fund at that moment And I've heard there can be tax advantages to for the investor sometimes. Yes Depending on the jurisdiction capital gains from selling stock might be taxed differently or later than dividend income Which is usually taxed right away. But again buybacks don't give you that steady income stream different appeal got it Okay. So with that framework, let's talk successes who has used buybacks really strategically not just as a gimmick But as part of a smart plan, well, you almost have to start with Apple. Yeah, they come up a lot since 2012 They've spent I mean, it's over 500 billion dollars on buybacks. It's the biggest program ever Staggering it is and what's interesting with Apple is how they did it Massive free cash flow. Yes, but also Bringing back billions earned overseas that cash repatriation. It wasn't just about EPS. It was a huge signal of confidence Management basically saying we think our stock is the best investment out there right now a powerful message What about other tech giants? Do they follow the same playbook? Microsoft is another interesting one. They also do significant buybacks, but they pair it with paying consistent dividends a Balanced approach right it signals balance We're investing in growth in AI in the cloud and we're returning capital to shareholders It shows you don't necessarily have to pick one over the other even in tech So it's not just about boosting the numbers. It's about the story the company tells with its cash What about say meta they've had some ups and downs met is a great example of using buybacks countercyclically almost when their stock price dipped significantly in 2022 2023 Amid all the metaverse skepticism, right? There was a lot of doubt. They actually increased their buyback program He was a strong signal for management saying look we believe in the long-term value Even if the market is shaky right now, we think our stock is cheap While still investing heavily in AI and their core platforms, of course reading their money where their mouth is essentially Okay stepping outside tech What about a more traditional maybe cyclical industry like energy ExxonMobil is a good case study there They tend to ramp up buybacks when oil prices are high and cash is pouring in makes sense But crucially they often pause or scale back those programs when prices fall during downturns Then they reinstate them when things boom again, like they did post 2021 It shows how buyback strategy has to adapt to the bigger economic cycles Especially in volatile sectors and we have to ask about Warren Buffett Berkshire Hathaway. He's always had a unique take Absolutely Buffett historically was very resistant to buybacks unless Berkshire stock was trading well below What he calculated as its intrinsic value. He's the ultimate value guy only if it's a real bargain Exactly, but interestingly in recent years Berkshire has significantly increased its buybacks Explicitly stating they felt the shares were undervalued So it's a pure value play for them not about managing EPS quarter to quarter But about buying their own business when they think it's cheap. So pulling back a bit from a CFO's chair What's the general appeal? Beyond these specific cases. Well, we mentioned flexibility. That's huge. They can also use buybacks to Sort of smooth out earnings per share make it look less volatile which analysts sometimes like okay And another big one is offsetting dilution from stock-based compensation when companies give shares to employees Right stock options and grants that increases the total number of shares Buybacks can counteract that keeping the existing shareholders slice of the pie from shrinking. Got it. Okay, we've heard the good the strategic. Yeah, but now Where's it get well really interesting? When do buybacks go wrong because like you said higher ETS doesn't automatically mean a healthier company No, it definitely doesn't and this is the critical part Buybacks can absolutely mask underlying problems if a company's core business is struggling, but they keep buying back stock The EPS might look okay or even good While the actual profits are falling exactly. Mm-hmm It can create a false sense of security or worse be used intentionally to distract from poor operational performance is there a really stark example of this a

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Cautionary tale deadbath and beyond is probably the poster child for buybacks gone wrong It's quite tragic really what happened there over several years They spent something like eleven point eight billion dollars buying back their stock billion with a B Billion even while their sales were visibly declining and a big chunk of that especially a large buyback in 2014 was funded with debt Yeah, so the stock might have popped temporarily, but the company got saddled with way too much debt over leveraged when things got tough They hit a liquidity crisis couldn't pay their bill and that led to bankruptcy in 2023 It's a textbook example of terrible timing ignoring fundamentals and using buybacks funded by debt in a way that ultimately destroy the company Wow That's sobering I also remember a lot of controversy on another big company during a crisis relating to buybacks you might be thinking of Boeing Yes, that sounds right between roughly 2013 and 2019 They spent a massive amount around 43 billion dollars on share repurchases Okay, then kovat hit air travel collapsed Boeing suddenly faced a huge liquidity crunch they had to stop the buybacks and Controversially ended up needing government support and the criticism was they should have kept that cash precisely the criticism was intense Why spend billions buying back stock instead of keeping a stronger cash buffer or investing more in R&D? Especially given the issues they'd had with the 737 MAX the optics were just terrible Yeah spending billions on buybacks then asking for help or laying people off that doesn't sit well It seems like a really delicate balance it is and you can contrast Boeing maybe with General Motors after their own crisis the 2008 restructuring How did they handle it much more cautiously? They eventually returned to buybacks, but gradually they avoided really aggressive repurchases Especially during uncertain times it showed a more disciplined approach focused on stability after having gone through financial distress So lessons learned perhaps and our regulators watching all this is anyone stepping in? Oh, definitely Regulators are paying attention in the US a 1% excise tax on stock buybacks was introduced in 2023 Makes them slightly less attractive financially a small tax But a signal exactly and the SEC the regulator has proposed rules for more transparency They want companies to disclose more about the timing and the reason for their buybacks. Why now why this much? So investors get a clearer picture right plus you add rising interest rates into the mix Suddenly funding buybacks with debt looks a lot riskier and more expensive than it did when rates were near zero Okay, that makes sense. So for a company's leadership team trying to make these calls What does smart capital allocation actually look like in practice? How do they decide if a buyback is the right tool? It's a constant juggling act really Modeling trade-offs you're always asking should we pay down debt? Is there a killer R&D project? We should fund should we start or raise a dividend or should we buy back shares? Lots of competing priorities. Is there maybe a sort of mental checklist? Questions they might ask themselves that maybe our listeners could use to when looking at a company Yeah, I think you could boil it down to a few key questions something like first Do we genuinely have excess free cash flow? Cash we don't need for operations or solid investments. Okay, is it truly spare cash? Second are our internal reinvestment opportunities kind of limited right now or maybe the expected returns just aren't that high if they're great projects They should probably come first makes sense. What else third and this is crucial Will this buyback really improve long-term value or is it mostly about juicing this quarters EPS number requires some honesty there Right looking beyond the short term fourth How does it impact our balance sheet our leverage ratios our credit rating? Are we taking on too much risk too much debt financial health check and maybe finally? Are we being transparent with our investors about why we're doing this? Can we clearly explain the rationale? That's a great checklist. It really drives home that buybacks aren't just a thing you do in isolation They're one tool in a much bigger financial strategy kit. Absolutely context timing underlying business health Yeah, it all matters immensely. Okay, so let's try to sum this up them sure so stock buybacks can be really smart They can be effective tools for allocating capital returning value Especially if a company stock is genuinely undervalued or they just don't have better places to put their cash at that moment But as we saw with bed bath and beyond Maybe Boeing to some extent When they're done for the wrong reasons just to hit an EPS target mask problems funded with too much debt time poorly They can be incredibly destructive a huge liability. So they're not a strategy on their own They're a tool and like any tool it really matters how and importantly why you use it Understanding that gives you the listener an edge right whether you're investing or just watching the markets It really does it makes you look past the headline announcement and ask why is this company doing this now? Does it align with creating actual sustainable long-term value?

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Or is it something else a much deeper question? So here's something to think about for you the listener as we see regulations potentially tightening interest rates, maybe staying higher economic cycles doing their thing How will companies balance that immediate satisfaction a buyback can provide with the longer term needs for innovation? Resilience even things like public perception. Yeah, that tension isn't going away. Definitely something to mull over We'll leave you with that thought until our next deep dive