Image source: NVIDIA.

Graphics chip company NVIDIA (NVDA 4.00%) hasn't been shy about buying back its own stock over the past few years. The company has a cash-rich balance sheet and generates plenty of cash flow, giving it ample ammunition to knock down its share count. Since January 2014, NVIDIA has spent a whopping $1.9 billion on its own shares, dwarfing the $523 million allocated for dividends.

What was the net result of this expansive buyback program, meant to return capital to shareholders? Surely, NVIDIA spending the equivalent of nearly 10% of its market capitalization on share buybacks over the span of a few years, some of which was done at lower prices, would make a serious dent in the share count. Would you believe it if I told you that all that spending has accomplished nothing? That the diluted share count, adjusted for some complications, is just about the same as it was prior to the start of the buyback program?

It's true. Investors should not be happy.

Throwing money down a hole

In January of 2014, the end of fiscal 2014, NVIDIA's diluted share count stood at 577 million. Two and a half years and $1.9 billion later, the adjusted diluted share count (I'll get to the adjusted part in a moment) stood at 588 million. Despite spending nearly $2 billion on share buybacks, the share count has actually increased.

On a GAAP basis, the situation looks even worse. NVIDIA's reported diluted share count at the end of the most recent quarter actually stood at 631 million. The discrepancy stems from convertible notes that NVIDIA sold in late 2013. NVIDIA used some of the proceeds to buy back shares, offsetting the dilutive effects of the sale, but the company also entered into a hedge transaction. In the event that the notes are converted to shares, which is now likely given the surge in the stock price, the hedge delivers shares to offset this dilution. The difference between GAAP and adjusted share count, 43 million, is due to this hedge.

Regardless of the details, it's clear that NVIDIA's share buyback program has not even managed to fully counteract the dilution caused by stock-based compensation. In other words, it turned a non-cash expense into a cash expense. NVIDIA has generated nearly $2.3 billion in free cash flow over the past two and a half years, but more than 80% of it was used to buy back shares just to keep the share count roughly constant.

I argued earlier this year that NVIDIA's most recent $500 million share buyback authorization was a big mistake, given how much the stock price had risen. The stock has nearly doubled since then, making buybacks an even worse idea. The stock trades at such a high multiple of earnings that NVIDIA is getting a terrible return on investment for every dollar it spends on buybacks.

Had the company eschewed buybacks entirely, the share count would be higher. In that sense, this spending did accomplish something, as earnings per share would be lower without it. But too often, spending on share buybacks is lumped together with spending on dividends as equivalent methods of returning capital to shareholders. NVIDIA is currently paying more than 40 times trailing-12-month earnings for its own stock. Investors would almost certainly be better off if that cash was returned directly as a dividend instead.

NVIDIA is not the only company that claims that its share buyback program is an effort to return capital to shareholders when, in reality, it's simply a way to balance out the dilutive effects of stock-based compensation. All that free cash flow doesn't mean much if most of it has to be used to keep the share count constant. Investors should demand a more balanced, dividend-focused approach from NVIDIA. Otherwise, billions of additional dollars may end up being wasted.