Exclusive Robert Arnott Interview: Should You Trust Share Buybacks?

There's been a big shift over the last few decades: Companies are using share buybacks to reward shareholders, rather than dividends. Buybacks are now the chief method of returning money to shareholders. S&P 500 companies spent $375 billion on share buybacks over the 12 months ended October 2012, versus $277 billion on dividends.

Some companies take this to the next level, spending a majority of net income on buybacks:


Share Repurchases (latest annual)

Net Income (latest annual)

ExxonMobil (NYSE: XOM  )

$22.1 billion

$41.1 billion


$15 billion

$15.9 billion

Intel (NASDAQ: INTC  )

$14.3 billion

$12.9 billion

ConocoPhillips (NYSE: COP  )

$11.1 billion

$12.4 billion

Pfizer (NYSE: PFE  )

$9 billion

$10 billion

Source: S&P Capital IQ.

From a big-picture standpoint, what should investors make of large share-buybacks? There are two points to keep in mind.

One is that timing matters. The biggest share-buybacks tend to happen when shares get expensive. S&P 500 quarterly buybacks topped out at nearly $180 billion in 2007, just as valuations peaked, and plunged to less than $30 billion in early 2009 when shares hit decade lows. Companies have an impressively poor record of timing share buybacks -- the classic "buy high, sell low" complex.

Secondly, buybacks consist partly of shares merely sopped up to issue to management as compensation. So, while a company may repurchase a large number of shares, the total shares outstanding won't necessarily decline over time. What looks like returning money to shareholders is really returning money to management.

Last month I sat down with Robert Arnott, CEO of Research Affiliates and one of the smartest investment minds around. I asked him what he thought about buybacks. Here's what he had to say (transcript follows):

Robert Arnott: I love share buybacks. I think that share buybacks are a wonderful stealth dividend. But they're not reliable. Companies announce share buybacks and often pursue them and often don't. Companies announce share buybacks linked to management stock-option redemption, so if I award stock to the management team, they instantly sell it -- that's the usual practice -- and we then institute a buyback of a like number of shares, that's not a buyback; that's facilitation of management compensation, and it should be viewed as such.

If buybacks could be as reliable as dividends, I would love them even more, but there's far more talk about buybacks than a reality of buybacks. Buybacks have been an off-again, on-again part of the landscape in the last decade. Before that, it happened with more buybacks than new share issuance in the late '80s, the Milken era, and before that, you have to go back to early to mid-'20s to find buybacks being an important part of the picture. So I don't trust buybacks. I love them, but I don't trust them.

Morgan Housel: Why don't more companies treat buybacks like dividends and say, we're going to buy back $200 million worth of shares per quarter, come rain or shine. We're going to treat it like our dividend. We're going to try as hard as we can to never cut it.

Robert Arnott: I'm the wrong person to ask that question. I think it would be wonderful if they did so. I think -- and I'm not certain of this -- but I think Bill Gates has for years done more or less that with his stock, a regular sale of the stock in the marketplace paired with Microsoft buying back stock from the marketplace. Microsoft has had a systematic program of buybacks for a long time. I don't know how reliable it is. I haven't studied it.


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