Revisiting Stock Buybacks

Bad for innovation and a bad investment

Over a year ago I wrote an article arguing against corporate stock buybacks in any amount that exceeds how much stock is issued in stock based compensation (SBC) to employees. My logic for the repurchase up to that SBC amount was that issuing stock to employees does dilute ownership by shareholders and therefore, using excess cash to repurchase that amount seems the right thing to do for shareholders. A reader pointed me to Ben Hunt’s articles on Epsilon Theory that argue pretty vehemently that this ‘sterilization’ is not returning money to shareholders (I agree) and points out that 100% of Meta's $96 billion and 90% of Google's $156 billion in stock buybacks went to sterilize new shares to employees. Hunt states, “I believe that there has been a truly astronomical transfer of wealth - well more than a trillion dollars - over the past ten years from shareholders of publicly traded companies to managers of publicly traded companies. Not founders, not entrepreneurs, not risk-takers ... managers.”

That little of this wealth was returned to shareholders is true. However, it absolutely does help remedy the dilutive effect of issuing stock to employees. I would also argue that the employees of these companies are investing in these companies as much as investors, just usually with their time and talent. Hunt also concedes that Apple only used 88% of its $550 billion in buybacks to shrink the share count and if you add the $130 billion in dividends, Apple has returned >90% of its free cash flow over the past 10 years to shareholders.

As a shareholder, you get to choose to invest in a company like Apple that does return most of it’s cash to investors or with companies like Google and Meta that use buybacks as anti-dilution strategies. Probably not surprising, I am personally fine with both strategies and am happy that employees get to share in the benefit of ownership in the company. My issue with stock buybacks isn’t using the available cash up to the amount of stock issued to employees, but rather when it goes beyond that. When a company spends excessively on buybacks that company by definition isn’t spending that money elsewhere like in R&D.

Impact on Innovation

The research paper, "Do Stock Buybacks Suppress Corporate Innovation?" by Tim Swift, examines whether large-scale stock repurchase programs hinder companies' investments in innovation, particularly in research and development (R&D). Swift notes that stock buybacks have surged, reaching over $1 trillion in 2018. Buybacks can increase earnings per share by reducing the number of outstanding shares, which, in turn, can raise share prices and benefit top executives whose compensation is often linked to stock performance. Critics argue that by prioritizing buybacks, companies may divert funds from potentially growth-driving R&D investments, thus compromising long-term innovation. Swift analyzed data from 682 firms finding a significant negative correlation between stock buybacks and the levels of corporate innovation as measured by R&D expenditure and patents produced. 

Swift’s findings provide empirical support for a broader concern, that excessive buybacks do not merely substitute R&D; they may actively hinder innovation. When companies prioritize buybacks over investments that foster long-term value, like research, product development, and infrastructure, they’re essentially trading future growth potential for present-day stock price gains. This shift creates a troubling dynamic. Executives, rewarded primarily on share price performance, are incentivized to channel free cash flow into buybacks rather than investing in new technologies, market expansion, or products. This is especially concerning in industries where R&D intensity is a key driver of competitive advantage, as a slowdown in innovation could diminish a firm’s future profitability and market position.

The impact becomes even clearer when observing companies that have pioneered tech innovations, only to later reduce R&D budgets while escalating buybacks. In these cases, the initial boost in shareholder value from buybacks may prove short-lived, as the pipeline of new products and improvements runs dry. Swift’s data analysis emphasizes that companies with high levels of buyback spending frequently exhibit reduced patent activity, a common metric of innovation. Reduced patent filings are not merely an indicator of lessened creativity, they suggest that companies are less prepared to adapt to shifts in market demand or to introduce new products that could capture consumer interest. Ultimately, companies caught in this cycle may face greater competitive risks as industry advancements outpace their own offerings.

The broader question, then, is whether shareholders should be satisfied with this shift in priorities. While buybacks might offer immediate financial gratification, long-term shareholders could see diminishing returns as innovation capacity weakens. Swift’s research raises an important dilemma for investors: whether they should favor the immediate benefits of stock buybacks or push for companies to allocate cash to initiatives that ensure the company’s long-term competitiveness. For many, the answer will depend on the company’s stage of maturity, industry context, and competitive landscape, but the evidence suggests that innovation investment could well be more beneficial for sustaining growth over time.

Good Investment?

Another way of looking at whether or not stock buybacks are good ideas is from an investment perspective. A stock buyback indicates that you can’t make use of that cash in any more profitable way than from purchasing your own stock. This often signals that the company thinks their stock is undervalued. However, this isn’t often the case. Research shows, many companies have ended up overpaying by buying at the wrong time. In a 2018 article, titled Save the Buyback, Save Jobs, despite arguing in favor of buybacks, it was noted that three out of every four companies in a sample of S&P 500 companies mistimed their repurchases to such an extent that their ROI on the buyback was below their total shareholder return. In other words, it was not a good investment. 

A 2015 article in the journal Economics, Management and Financial Markets, stated: 

Often touted and viewed as a value creating strategy, historical reports suggest that the longer term results of stock repurchases are fairly unpredictable. Empirical evidence has shown that positive abnormal returns often do accrue to companies announcing stock repurchase programs in the short term, but longer term value creation remains speculative and highly questionable. 

So, in the short term, buybacks do provide a positive return as measured by market capitalization but in the long term this is often not the case. It’s hard to pinpoint when the returns should occur from a buyback. I would argue that the market trades on information so at the point of being announced the price change of the buyback should be priced into the stock. In other words, within a day of trading, the value gained from the buyback will be established. 

Let’s look at a real world example. On Dec 7, 2022 Lowes announced plans to buy back $15 billion in stock in addition to a previous program that reached $6.4 billion. The stock buyback has no expiration date. Shares jumped 3.4%, to $208.73 on that Wednesday, while the S&P 500 dipped 0.3%. The week before (Dec 7, 2022), Lowe’s market cap was $129.91B. The day after the announcement, there was an increase of $4.3B in market cap. However, the next week the market capitalization dropped to $124.65B and a year later in Dec 2023 the market cap was $129.74B, essentially unchanged. Was that a good investment of $15B? Perhaps they were offsetting employee stock-based compensation to ensure their shareholders weren’t being diluted. 

In Lowe’s 2023 annual report they state, “Since 2018, we have invested over $3.5 billion in incremental wage and share-based compensation for our frontline Associates” and “The Company recognized share-based payment expense within SG&A expense in the consolidated statements of earnings of $210 million, $224 million, and $230 million in 2023, 2022, and 2021, respectively.” So while they are certainly generous with employee share-based compensation, it was clearly not the only reason for the stock buyback. Of course, this analysis is overly simplified in that it doesn’t take into account the company’s actual performance or their guidance or the economy or the market in general. You could absolutely make a case that the buyback was a great investment compared to anything else the company could have done during that period with the cash. However, I would make an argument that there was probably a better investment for that money, even a simple savings account, and I think folks like Ben Hunt would argue that they should have paid out more in dividends. 

Market Manipulation

Stock buybacks are often lauded for their potential to increase shareholder value by reducing the number of outstanding shares, thereby inflating earnings per share (EPS) and potentially driving up stock prices. However, this practice has long been scrutinized for its broader implications, particularly as a mechanism that can distort market behavior.

Critics argue that buybacks enable executives to engage in self-serving behavior, boosting stock prices to trigger performance-related bonuses. This practice redirects funds that could otherwise be invested in growth-oriented activities such as R&D, infrastructure, or workforce expansion. According to a 2014 article in Harvard Business Review, this misallocation of resources benefits a narrow group, typically executives and short-term shareholders, while eroding the company’s long-term sustainability and prosperity​. Further, an op-ed from the Michigan Journal of Economics pointed out that buybacks can undermine the broader economy by diverting resources away from innovation and sustainable practices. Instead of fostering long-term growth, the emphasis on buybacks creates a cycle that inflates stock prices temporarily but can lead to stagnation or decline when these funds are not reinvested back into the company​.

One of the core arguments against excessive buybacks is their manipulation of supply and demand. By reducing the available shares on the market, companies artificially inflate their stock prices, a move that may not reflect the actual economic health or operational performance of the business. This artificial inflation can create a misleading picture for investors, who may interpret rising stock prices as a sign of robust financial health and growth, rather than a strategic reduction in share count. The result is a market that rewards superficial metrics over substantive gains in productivity or innovation.

As Representative Sean Casten notes, this practice was once deemed manipulative enough to warrant its prohibition. The historical perspective adds weight to current debates, as buybacks were illegal before 1982 due to concerns about their potential to skew market prices and disadvantage ordinary investors. The original ban underscored the belief that such practices manipulated the market in ways that compromised fairness and transparency, fostering a stock market that privileged insiders and large shareholders at the expense of broader economic health. Re-legitimizing buybacks with the adoption of SEC Rule 10b-18 in the early 1980s was intended to provide a regulated pathway for companies to repurchase shares without undue influence. However, the rule has been criticized for lacking stringent oversight, allowing companies significant leeway in executing buybacks. This reintroduced the same market-distorting behaviors that once prompted the practice’s prohibition, reinforcing concerns that today’s buybacks might prioritize short-term optics over long-term value creation.

While stock buybacks might offer immediate gains for shareholders, their impact on innovation, company growth, and economic stability remains questionable. Investors should critically evaluate whether the companies they support prioritize short-term boosts over sustainable development.

Conclusion

Stock buybacks are a complex financial tool that, when used judiciously, can benefit shareholders by offsetting stock-based compensation and modestly returning value. However, the widespread and often excessive use of buybacks raises significant questions about their broader impact on innovation, long-term investment, and market fairness. As highlighted by research and historical perspectives, buybacks can suppress investments in R&D and create misleading financial optics, prioritizing short-term gains over sustainable growth.

Moreover, the practice can distort the market by manipulating supply and demand, inflating stock prices without necessarily improving a company’s operational health. This not only benefits top executives disproportionately but can also contribute to economic fragility when resources are diverted away from projects that foster long-term development. The historical context that once led to the prohibition of stock buybacks serves as a reminder of their potentially manipulative nature, reigniting debates about whether current regulations are sufficient.

For investors, the decision to support a company’s buyback strategy should go beyond the surface-level appeal of immediate gains. It is crucial to assess whether these actions align with sustainable growth and the long-term health of the company. As the conversation around buybacks continues, both investors and policymakers need to question whether the current approach is conducive to fostering a stable, innovative, and transparent market.