Rethinking Share Buybacks

One of my 2010 posts, "Black and White," has been generating quite a few views recently. In it, among other things, I discuss share buybacks, which are in the media again as the market swoons and companies have excess cash.

As CFO of Possis Medical, once our downsizing, business model realignment and strategic focus had taken hold, the company was generating substantial free cash flows, in excess of business needs. We decided to embark on a share buyback program, not for financial engineering purposes, but primarily to use some of the excess cash to offset dilution from options grants to executives and key employees as the company continued to grow. Unlike most corporate programs which are announced but expire unfulfilled, we bought back about 10% of the outstanding shares. It was a good trade overall too--we didn't buy high!

Especially for the companies in the S&P 500, whose stocks are hyper-actively traded in native and derivative forms, I'm not sure that buybacks are the best thing for rewarding all shareholders. Increasing the dividend, when stocks like Intel are already yielding almost 4%, may also not be the best, as then the new level cannot be reduced without price consequences. I believe that one-time, special dividends are a good answer to using excess cash and for rewarding all shareholders, those who stay and those who collect and move on later. Hawkins, Inc., a company whose board I served on as audit committee chair, used this special divided in a response to some positive, one-time events. The permanent payout level stays the same. I think that this tool ought to be used more often.

Thinking about the one-day announcement effects of a share buyback, behavioral market analysts have posited a good explanation. Shareholders are so relieved that their managements are not immediately announcing a mega-value busting acquisition, they bid the stock up in the short term! It's not an unreasonable explanation.