Buybacks have been on the rebound since 2013, now reaching the highest point since the financial crisis sparking a slew of articles trying to figure out whether we should be worried about this returning trend. As something of a palliative to calm down investors, NYU Stern School of Business professor Aswath Damodaran focuses on how buybacks affect corporate valuation in his recent blog post and decides that both “the shameless boosters of buybacks, who treat it as a magic bullet, at one extreme, and the equally clueless Cassandra chorus, who view it as the market equivalent of the Ebola virus, signaling the end of Western civilization as we know it, at the other” are over reacting.

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Buybacks are simply a way to return cash, says Damodaran

Damodaran’s main argument is simply that buybacks are a form of cash return, like dividends, and most investors shouldn’t be overly concerned about which one dominates from year to year. Buybacks have the big advantage that they return value to everyone while letting individual shareholders decide if they actually want to take part and get cash, giving them more control over their taxes than dividends, and Wall Street culture tends to punish stocks that decrease dividends but not those that decrease buybacks (for whatever reason). Buybacks also change the share count, but this shouldn’t change a company’s market value aside from a small bounce when the company actually executes its buyback program.

Buybacks

But the big difference is that dividends give everyone the same amount of cash, while dividends transfer wealth among shareholders unless the stock is perfectly priced. If the stock is overpriced then those who sell benefit at the expense of those who hold onto their stocks; if the stock is underpriced then the opposite happens.

Buybacks

The question of whether a company should return cash to shareholders in either way ultimately depends on whether they have better options available to them. Shareholders who trust management only to invest in projects with return above the cost of capital should be happy to leave money in their hands (Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) is probably the best example), but watching Apple Inc. (NASDAQ:AAPL) sit on a pile of unspent cash prompted Carl Icahn to push for a much larger buyback program.

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Buybacks may still be a sign that something is wrong

The real issue, which Damodaran only addresses briefly, is that buybacks were low when stock prices were depressed post-crisis, and they are rising now along with the market. Add in the fact that management of large traded companies typically get a lot of their compensation in stock options and the buybacks start to look like a transfer of wealth from owners to managers. The alternative, that corporate managers are acting in good faith, but they really can’t find anything else worth investing in, is a positive from the corporate governance perspective but no more encouraging about the fate of the recovery.