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(Note: companies that could be impacted by the content of this article are listed at the base of the story (desktop version). This article uses third-party references to provide a bullish, bearish and balanced point of view; sources listed in the "Balanced" section)

Stock buybacks are on the rise and there are concerns over the effectiveness. It is even becoming a Political issue. Share buybacks, also known as stock repurchases, are when corporations purchase its own shares in the open stock market, reducing the total number of shares outstanding. The result of the buyback could increase earnings per share and increase return on equity, possibly increasing the stock price. 2018 was an all-time, record year for buybacks, with $1.1 trillion in announcements and some $800 billion repurchased during the year. Reasons have been postulated about why the pace of buybacks has increased over the years, including the generation of significant free cash flow by companies, muted organic investment opportunities, a lack of accretive acquisitions, as a means of boosting EPS by reducing the share count. Notably, stock repurchases were illegal until 1982 and Congress is looking at curbing the exercise as a means of narrowing the growing income inequality in America and advocating an element of social responsibility. Senators Charles Schumer and Bernie Sanders penned an op-ed in the New York Times arguing that, “corporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers.” The pair suggest they will introduce legislation to limit buybacks unless companies meet certain conditions, including a $15 per hour minimum wage, providing workers with decent pensions, and solid health benefits, among other things.

S&P 500 Firms Are a Small Subset of the Overall Economy. To properly assess the impact of buybacks on the health of the U.S. economy, one must look at the effect on all companies, not just S&P 500 companies. S&P 500 firms account for less than 50% of business profits and less than 20% of employment. Funds received from buybacks by shareholders of S&P 500 companies does not go down a black hole. Instead much of the cash is used to invest in smaller public and private companies, supporting innovation and job growth. In fact, private firms account for more than 50% of nonresidential fixed investment, employ almost 70% of U.S. workers, and generate nearly half of all business profits.

Executives Make Up a Tiny Portion of the Wealthy. S&P 500 executives make up a tiny portion of the top 0.1% of the U.S. Economy (about 120,000 households) and account for an even smaller portion of the top 1% (about 1.2 million households). Even if shareholder payouts boosted each executives pay by 20% per year, it would barely cause a budge in inequality.

Buybacks Do Not Crowd Out Other Investment. While it is true that from 2007-2016 outflows for buybacks and dividends represented some 96% of S&P 500 companies’ net income, this analysis ignores the amount of capital raised through share issuance over the period. Adjusting for capital raising reduces these payouts to just 50% of net income.

Stock Ownership is Widespread. According to the Federal Reserve Bank of St. Louis, the share of middle-aged households with direct or indirect stock holdings rose from 40% in 1989 to 61% in 2001 and since then has fluctuated between 57% and 62%. Therefore, any benefits in terms of share price increase from buybacks benefits a significant number of people, not just executives.

Capital Expenditures Continue to Grow. Strategas Research Partners estimate that capital expenditures by S&P 500 companies grew $75 billion in 2018, the fourth largest annual gain since 1991.

Rise of Technology and Health-care Companies as Percentage of S&P 500 Distorts Old Measurement Techniques. Due to accounting rules, R&D expenditures, the primary capital expense of Technology and Health-care companies, are treated as operating expenses, not capital expenditures, depressing the reported capital expenditure amount of S&P 500 companies.

Buybacks Being Utilized by Firms With Low Expected Growth. According to research by Aswath Damodaran, approximately 60% of companies earn less than their cost of capital. Such firms should be returning capital to shareholders. Damodaran also found that the biggest buybacks are for companies that have the lowest expected growth in revenues. Again, slower growing companies with muted re-investment prospects should be returning capital to shareholders.

Workers at Large Buyback Firms Typically Earn Higher Than Average Wages. Damodaran again, “The workers at firms that buy back the most stock tend to be already among the better paid in the economy, and tying buybacks to higher wages for these workers will not help those who are at the bottom of the pay scale.”

Capital Expenditures Continue to Grow. Strategas Research Partners estimate that capital expenditures by S&P 500 companies grew $75 billion in 2018, the fourth largest annual gain since 1991.

Buybacks Reflect Short-term Thinking. Critics claim buybacks are used to game the next earnings report to appease Wall Street and to juice executive compensation metrics.

Buybacks Benefit Executives. Stock-based instruments make up the majority of executives’ pay and with buybacks providing short-term boosts to stock prices, buybacks will provide excess compensation to executives. In 2012, 42% of the compensation of the highest paid S&P 500 executives came from stock options and 41% from stock awards.

Buybacks Shortchange Investment. From 2007 through 2016 S&P 500 firms paid out $7 trillion to shareholders - $4.2 trillion through buybacks and $2.8 trillion through dividends, representing some 96% of net income. Researchers at Deloitte point out that buybacks and dividends have soared as a share of GDP whereas investment in equipment and infrastructure has remained stagnant.

Buybacks Negatively Impact R&D. According to a 2015 study by U.S. economist Heitor Almeida, share buybacks can have a detrimental effect on research and development spending.

Buybacks are Reducing the Number of Listed Firms. There are half as many listed firms in the U.S. than 20 years ago, largely due to buybacks. U.S. capitalism is gradually becoming non-quoted.

Employees suffer. An analysis of companies on the Russell 1000 Index found that companies directed 10 times as much money to buybacks as to workers. Growth in employee wages has been slow and sporadic, with the 1998-2000 time frame the only period in the last 46 years when real wages rose by 2% or more for three consecutive years.

Buybacks Reflect Short-term Thinking. Critics claim buybacks are used to game the next earnings report to appease Wall Street and to juice executive compensation metrics.

Buybacks Negatively Impact R&D. According to a 2015 study by U.S. economist Heitor Almeida, share buybacks can have a detrimental effect on research and development spending.

Buybacks are Reducing the Number of Listed Firms. There are half as many listed firms in the U.S. than 20 years ago, largely due to buybacks. U.S. capitalism is gradually becoming non-quoted.

Bringing the heat. The case of corporate buybacks generates heated discussion on both sides. Nonetheless, let’s leave the final words to Warren Buffett. At the 2004 Berkshire Hathaway annual meeting Buffett said, “When stock can be bought below a business’s value it is probably the best use of cash.” According to the Oracle of Omaha, buybacks, when done right are a value investment. Anytime you can buy stock for less than it’s worth, it’s advantageous to the continuing shareholders, but it should be by a demonstrable margin. Back in 2004, Mr. Buffett stated, “The best use of cash, if there is not another good use for it in business, if the stock is underpriced is a repurchase.”

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