Share BuyBacks
Neither Good Nor Evil
Neither Good Nor Evil
I tend to view capitalism as the great innovation of modern Western society. Its adoption has enriched everyone even if it has made some substantially richer than others. Wealth is a zero sum game. One need only look at the landscape of modern life to see cities and industries, telecommunications networks, vast transportation systems and more, to see that where once there was nothing except wilderness, NOW there is wealth.
Do some abuse the system? Yes. There are courts for that. But, let's not throw out the baby with the bathwater. In my pro-capitalism series of blogs, I will address the areas often cited (incorrectly) as examples of badness in capitalism. My first entry... Share BuyBacks. Enjoy.
Share buybacks get a bad rap from people who assume that corporations are inherently manipulative and exploitative. But the truth is far less dramatic.
Share buybacks are simply a tool - a way for shareholders to liquidate ownership and for companies to take advantage of an undervalued stock price.
If a company has excess cash after meeting its vendor, employee, and operational obligations - AND if the stock price materially undervalues the company's economic engine - AND if leadership does not see a better use for that capital - then a share buyback can be not only reasonable, but prudent.
In many cases, a buyback signals confidence. Outside investors recognize that fewer shares outstanding means each remaining share represents a larger claim on future earnings. Demand increases. Valuation corrects.
Still, it can be difficult to understand how this works at a macro level. So let's simplify it with a two-person company.
Imagine two people - Kelly and Sandy - who met at their place of employment and worked together for several years.
They often talked about leaving to start a business of their own. They got along well enough to cut expenses and share an apartment. They cooked at home instead of eating out. They shared one vehicle.
They saved.
And they saved.
Eventually, they gave notice and each contributed $50,000 in share capital to start XYZ Incorporated. Each became a 50% owner - one of two issued shares.
At first, the business made very little money. They were grateful for their frugal living arrangement and mutual support.
Over time, things improved. They grew their customer base and their team. Some years were strong. Others were barely survivable.
There were stretches where they earned less than their best employees - and periods where they took no pay at all just to meet payroll.
They learned to pay well to retain good people.
They learned to fire quickly when someone proved toxic.
They learned to save aggressively when times were good.
Whenever possible, they set aside cash to protect the business during lean periods. Much of this reserve was held in bonds - conservative, liquid, and accessible if payroll ever came under pressure.
Occasionally, they had to lay people off. It was emotionally draining, but they understood that preserving the company itself was sometimes the only way to protect those who remained.
After many years, the business reached stability:
The toll, however, was real. The stress. The long weekends. The years of uncertainty. Kelly decided it was time to retire.
A third-party valuation firm appraised the company at $2M, based on:
Sandy wanted to continue running the business but lacked the personal liquidity to buy out Kelly. So they explored another option.
The company itself would redeem Kelly's share - a share buyback - using $800,000 from its bond portfolio.
Kelly accepted a slightly discounted redemption in exchange for certainty, liquidity, and a clean exit. Sandy benefited from the discount and retained a prudent cash buffer, leaving $200,000 in reserves.
Sandy now owned 100% of the company. The number of shares was reduced.
After the transaction:
The company was now valued at $1.2M - the same 10× multiple on operating profits, plus remaining cash.
Nothing magical happened.
No value was created out of thin air.
Ownership was simply concentrated.
Now scale this up to a public company.
Instead of two shareholders, there are millions.
Instead of $5M in revenue, there is $5B.
Instead of $100K in profit, there is $100M.
Instead of $1M in reserves, there is $10B.
Management observes that the market is undervaluing the company relative to its fundamentals. Growth opportunities are limited. Balance sheets are strong. Excess capital is sitting idle.
So the company repurchases shares in the open market - while preserving adequate reserves for downturns, capital expenditures, and operations.
The result?
The operating engine remains the same - but ownership becomes more concentrated.
That is a share buyback.
Share buybacks are not financial trickery. They are not inherently good or bad.
When used prudently - when shares are undervalued, growth returns are limited, and balance sheets remain healthy - buybacks are a valid and powerful capital-allocation tool at both small and large scales.
And just like everything else in life and business, the insight comes from inversion:
Don't ask "How do we reward shareholders?"
Ask "How do we avoid misallocating capital?"
Sometimes the answer is to buy growth.
Sometimes it's to pay dividends.
And sometimes - the best move is to reduce the number of shares and let ownership quietly compound.
The next time someone speaks of the "evils" of share buybacks, remember this: the company pays real money to acquire those shares, reduces the public float, and increases ownership concentration.
As long as the company is not over-paying, a share buyback is not exploitation - it is disciplined capital stewardship.
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