They benefit long-term owners of great businesses
Everyone loves dividends. Buybacks don’t get the same affection—but they should. This is probably because they’re a bit misunderstood.
When a company pays a dividend to shareholders, it’s pretty easy to see the benefit. Cash goes from the company’s coffers directly into the shareholder’s pocket.
But when a company uses its cash to buy its own shares and retire them, this increases all remaining shareholders’ ownership position in the company. Think of it this way—if you own the same number of shares as yesterday, but today fewer shares exist, then the company has used its cash to increase your ownership stake.
This is less direct than a dividend, but potentially more powerful for long-term returns. Why? If you own more & more of a company that’s doing well, you can potentially compound your capital at a higher rate.
There’s no better example than Apple over the last 10 years:
Apple began repurchasing shares in 2013. The company has reduced the total shares by about 40%
While Apple has been paying a dividend for more than a decade, the majority of the cash returned to shareholders has been from stock buybacks. This has reduced the total number of shares in the company that exist and effectively increased the ownership of all the remaining shareholders.
Apple’s stock is up about 1100% over the last 10 years. While the market simply values a dollar of Apple’s earnings more than it used to, share buybacks have meaningfully contributed to the company’s growth in Earnings Per Share (EPS), the fundamental basis for the value of the stock.
Buybacks are not without risks. There are numerous examples of companies that bought back their shares only to see the business shrink. Owning more & more of a failing business is not a strategy we would like to employ. That’s why it’s crucial to own a collection of thriving companies. When these high quality companies purchase and retire shares, this provides an additional tailwind for investors that shouldn’t be ignored.