The conventional wisdom in capital markets that stock buybacks inherently return value to shareholders requires critical reassessment. While strategic buybacks employed by management teams can indeed benefit shareholders, a prevailing lack of a systematic approach to evaluating a company's intrinsic value has led to widespread buyback strategies that, contrary to popular belief, often erode shareholder value.

Historically seen as market manipulation, the legal landscape for stock buybacks changed in 1982 with SEC’s Rule 10B-18, introducing a Safe Harbor provision. This was a pivotal shift intended to empower companies against corporate raiders and to solve principal-agent problems. Since then, buybacks have surged in popularity, surpassing dividends as the preferred method of returning capital to shareholders, with over $1.1 trillion executed in 2022 alone.

The issue at heart is the timing and rationale behind buybacks. Companies often engage in increased buyback activity during market upswings when shares are likely overvalued, while greatly limiting or restricting such activities during more challenging market conditions. This embodies a "buy high, sell low" mentality that contradicts the basic investment principle of buying low and selling high. This behavior is compounded by the fact that many CEOs perennially view their company's stock as undervalued, leading to buybacks even when stock prices are inflated.

The argument for a counter-cyclical approach to buybacks, where companies engage in repurchasing shares when prices are low, aligns with the principle of buying low and selling high. This strategy not only provides genuine value to ongoing shareholders but also ensures that buybacks do not serve merely as a tool for EPS manipulation or to offset dilution from stock-based compensation.

Additionally, it is relevant to reevaluate buyback strategies in light of recent regulatory changes, such as the Inflation Reduction Act's excise tax on net buybacks and the SEC's new disclosure requirements. These changes present an opportune moment for companies to revisit their capital allocation strategies, potentially incorporating special dividends as an alternative method of returning value to ongoing shareholders.

Special dividends offer a straightforward, commitment-free way to return capital, particularly during business cycle upswings. This approach, while less common, signals a shareholder-centric perspective, distinguishing companies willing to prioritize direct shareholder value over market perception.

The prevailing narrative that unconditionally champions buybacks as a mechanism for returning shareholder value is both simplistic and potentially detrimental. Analysis underscores the importance of a judicious, market-informed approach to buybacks, urging management teams to exercise greater discernment and strategic thinking in capital allocation.

By aligning buyback policies with rational market conditions and exploring alternative methods of returning value, companies can foster a more sustainable and shareholder-friendly capital management strategy. It's time for a shift in perspective from a one-size-fits-all approach to a more nuanced, value-oriented strategy, ensuring that capital deployment through buybacks genuinely enhances long-term shareholder value.

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Deiya Pernas, CFA, Co-Founder of Pernas Research, began his career as an analyst at Morgan Stanley before becoming a founding member of The Bahnsen Group. As Deputy Chief Investment Officer, he played a pivotal role in growing assets from $500 million to over $3.5 billion. In 2022, he founded Pernas Research, aiming to provide insightful, transparent, and performance-driven equity research for investors.