Stock buybacks are a double-edged sword. By reducing share counts, they can boost the value of each remaining share. But if management buys back shares at too high a price, it's effectively destroying value. Worse yet, spending money on buybacks and dividends can also rob companies of other opportunities.
A company can do any number of things with the money it earns: Pay down debt, buy another company, build another factory, hire more workers, buy more advertising, pay out a dividend, buy back shares, or just let the money pile up. Great companies use their dollars wisely.
If a company pays a dividend or buys back shares at a fair price, shareholders will profit. But neither of those steps will make the company bigger, stronger, or better positioned. Devoting that money toward building the business instead might ultimately benefit shareholders even more. That's why Warren Buffett has resisted paying a dividend for so long. Letting cash pile up has permitted him to make the occasional huge purchases for which he's famous.
Coffers and offers
Some investors have suggested that Cisco might buy Research In Motion
The big picture
These and other companies' buyback and dividend moves aren't necessarily dumb. In the current economic environment, big and healthy companies can borrow large sums of money for very little, giving them greater flexibility. But few companies will qualify for the best deals. And in any economy, it's useful to think about exactly how a company is spending its cash, and whether it's losing out on any more attractive opportunities in the process.
Some dividends are not just suboptimal -- they're downright crazy!
Longtime Fool contributor Selena Maranjian doesn't own shares of the companies mentioned. The Fool has a bull call spread position on Cisco Systems. The Fool owns shares of Oracle. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.