Once a little-known and nebulous idea, share buybacks have recently become a hot topic that lies at the intersection of business, investing, and politics.

Corporations have been increasingly opting to repurchase their own stock in recent years, thereby returning cash to shareholders in a nontaxable way, propping up earnings per share for remaining shareholders, and giving a vote of confidence in the business's future prospects.

For various reasons, presidential hopefuls like U.S. Sens. Elizabeth Warren and Bernie Sanders have called out the practice and made proposals to limit or ban them. Most corporate boards obviously argue the other direction.  

Warren Buffett speaks to reporters at an event in Omaha, Nebraska

Warren Buffett. Image source: The Motley Fool.

Some organizations that have made a regular habit of repurchasing shares in recent years are now in a cash crunch and are suspending repurchases at the most opportune time given the recent stock market drubbing. The world is looking at the airline industry as a major culprit, but there are plenty of other bad players. On the day of this writing, Intel (INTC 2.13%) was the latest to announce it was also suspending its repurchase plan.  

Turns out, given recent developments surrounding the coronavirus pandemic and efforts to slow its spread, famed investor Warren Buffett's balanced view of the practice was correct all along.

Buffett's view should have rung true

Rather than try to explain Buffett and his longtime business partner Charlie Munger's thoughts on share buybacks, a direct quote from him might explain it easier. Buffett wrote in his annual letter to Berkshire Hathaway (BRK.A 0.58%) (BRK.B 0.38%) shareholders in late February 2020:  

In past reports, we've discussed both the sense and nonsense of stock repurchases. Our thinking, boiled down: Berkshire will buy back its stock only if A) Charlie and I believe that it is selling for less than it is worth and B) the company, upon completing the repurchase, is left with ample cash. 

Calculations of intrinsic value are far from precise. Consequently, neither of us feels any urgency to buy an estimated $1 of value for a very real 95 cents. In 2019, the Berkshire price/value equation was modestly favorable at times, and we spent $5 billion in repurchasing about 1% of the company.

Over time, we want Berkshire's share count to go down. If the price-to-value discount (as we estimate it) widens, we will likely become more aggressive in purchasing shares. We will not, however, prop the stock at any level.

As always, the letter in its entirety needs to be read by investors of all types. Here's a link to it

What this means for corporate America

I want to make it clear this is in no way a political statement of any kind. This is more a statement about what constitutes good corporate governance. Recent events are exposing the corner many businesses have worked themselves into. While not all share repurchases have been faulty, many have been breaking Buffett's two very basic -- but important -- rules: Purchasing stock when it's valued for less than it's worth, and leaving the business with ample cash.

Each company can value itself differently, but indiscriminately making regular purchases to boost earnings is neither prudent nor good investing sense. That's more akin to purchasing an index fund with savings every single month. Individual businesses, though, are not index funds.

And as for the latter point, Berkshire's cash, equivalent, and short-term security hoard amounted to $128 billion at the end of 2019, even after the company made $5 billion in buybacks. Investors have been eyeing the sizable cash line item for years as it has continued to expand. But, to quote Buffett again, "Only when the tide goes out do you discover who's been swimming naked." Berkshire may have ample liquidity, but it will not be faulted for swimming naked.

To pick on Intel, its decision to suspend its buyback right now is frustrating. The company retired nearly 5% of its outstanding share count last year. Between that and its dividend payment (which, worth mentioning, is not being suspended), Intel returned $19.2 billion in cash to shareholders even though it only generated $16.9 billion in free cash flow (money left after cash, operating and capital expenses are paid). Where did the extra cash come from?  

It came off of the balance sheet. Now to be fair, Intel's revenue and net income (which measures the bottom line without the extra boost of buybacks) have both been trending north over the last decade, so repurchases aren't completely unwarranted. However, along the way, debt has gone up dramatically, and cash has been held relatively constant. Intel had $5.2 billion in cash and equivalents at the end of 2019, plus another $7.8 billion in "trade assets." While buybacks have been a wonderful bonus for owners of the stock, keeping extra in reserve for times such as the world finds itself in now would have been far better. Hindsight is, of course, 20/20, but the business and investing world know that disruption happens. When the market swings wildly, then is the ideal time to buy. 

INTC Total Long Term Debt (Quarterly) Chart

Data by YCharts.

For the sake of illustration, after hitting fresh highs in late February, Intel stock has been down by as much as 35% in the last month. In stark contrast with moves other companies have been making, cybersecurity firm Palo Alto Networks (PANW 3.26%) announced an accelerated share repurchase worth $1 billion to be executed during the current quarter. Its stock has been down as much as 50% from recent highs. Palo Alto Networks has its faults too, but that's how you execute a share repurchase program.  

Investors, don't ignore the balance sheet

Since this is an investing piece, there are several supremely important lessons here. In an investment community that had become hyper-focused on growth and momentum, the coronavirus health scare and the ensuing response is a reminder that nothing goes in a straight line. Be prepared.

Knowing that, remember that cash is called king for a reason. While it doesn't provide any growth, there are times when it must be had, and in the moment of crisis is the wrong time to start looking for it. Be the person who is alarmist early, not late, and always keep some powder dry.

And finally, while a company's growth trajectory is important, don't forget to check its balance sheet. Revenue, earnings, and per-share earnings metrics get tons of attention, but that's still only a piece of the picture. Businesses that play fast and loose with cash balances and debt should be avoided. It's unfortunate that Buffett's counsel on such matters will be taken seriously after the fact, and the effects felt in the business and investing world because of ignoring the sage wisdom are likely to be felt for a long time.