“Once more unto the breach, dear friends, once more.”

The universally respected and admired Michael Mauboussin has chimed in on the now political issue of share repurchase programs. His opinion piece in the FT this week in defense of them tries to clear up what he considers “confusion and sloppy thinking” critical of buybacks. Cliff Asness, his equally formidable ally in support of buybacks, has made similar points in print recently.

Wrestling with either of these finance heavyweights is done at one’s peril. But I can’t help but add some additional color around their assertions from the perspective of a dividend investor. I’ve spent the past two decades competing for company cash with other investors and executives who favor buybacks.

First, I wholeheartedly agree with Mauboussin that the new 1% tax proposed by the administration is bad policy. It will be ineffective. The new levy will not dissuade; it will not raise much money; it will do nothing other than make a long tax code even longer. I also agree that buybacks are not starving companies of investment. It’s just a bad use of free cashflow, not an alternative to investment.

That being said, we’ve now had more than three decades of neo-liberal globalism which has favored outsourcing, off-shoring, and margin improvement and earnings growth above all else. Encouraged by the capital markets, corporate America has privileged short-term efficiency over long-term efficacy. Mauboussin’s piece is brief and doesn’t take up the investment issue in detail, but I do believe that corporate America is due for an investment “reset” that will amount to many hundreds of billions of dollars. It has not been necessary in the past few decades—the system “worked”—but it will be desirable for many companies in the years ahead. Those funds will come from cashflow that now goes to buybacks.

Mauboussin properly notes the tax difference between dividends and the (hopefully) harvested capital gains purported to result from buyback activity. While the levy rates are generally the same, one can be timed or deferred. The other happens on a fixed schedule. There is no denying the benefit of timing taxable events. Indeed, the academic community has pummeled dividends for that very reason for a half century. I still hold the position that investors should not subordinate investment policy to tax policy, not least because no- and low-dividend stocks tend to be much more volatile than steady payers. My view is clearly a minority one…

Mauboussin makes the broader point that buybacks do not add or detract from corporate value. They just shift it around. The winners and losers are among the investors themselves. This is standard market theory. My issue is who initiates the process, the widget maker or the investor. I prefer the investor setting that sequence of events in motion, not the widget maker’s management team. Mauboussin also briefly touches upon the use of buybacks by management to juice their compensation. His argument in favor of buybacks would be stronger for addressing it more than he does.  That material portion of buybacks used to offset issuance is really just employee compensation, not “returning cash to shareholders.”

I would also push Mauboussin on his view that what he calls “sorting” allows shareholders to equal up the benefits of buybacks and dividends. While all investors get dividends, only sellers “benefit” from buybacks (assuming they create the opportunity for capital gains). He suggests that holders can synthetically make up the difference with tactical sales: “A shareholder can create a homemade dividend by selling shares in the same proportion at which the company is buying. They will be left with cash and the same percentage ownership in the company.”  In theory that may be true, but as a practical matter, there is a different sorting that occurs. High yielding companies rarely have major buyback programs.  And the big buyback companies are rarely owned for their income streams, which in the 0% or 1% range typical of the leading US stock market names is inconsequential. So the academic equivalence of a buyback-based capital gain vs a dividend fails at the individual company level.

The broader issue is not financial but philosophical.  A dividend payment is a business outcome. An investor trying to harvest a capital gain from a corporate seller is a market outcome. The former is in the realm of the widget maker making widgets. The latter involves literally thousands of market participants and intermediaries and has nothing to do with widget making. In the classical finance model, there is no difference between dividend and harvested capital.  In reality, they couldn’t be more different.  Mauboussin notes that the original 1982 legislation permitting buybacks had provisions designed to prevent companies from manipulating their share prices. I would also note that the legislation coincided with the highwater mark of interest rates. Declining interest rates and rising markets ever since have made buybacks look good and masked important differences compared to dividend payments. Whether that tailwind for buybacks will continue in the decades ahead remains to be seen.

FT Opinion Piece