Share buybacks elicit strong opinions.  For instance Eddy Elfenbein at Crossing Wall Street recently wrote:

I’ve said here many times that I’m not a fan of stock buybacks. I think they’re a waste of shareholder money and I’d much rather see that money flow to shareholders in the form of cash dividends. Unfortunately, the tax code isn’t very helpful in these matters.

Research now indicates that managers favor buybacks over dividends not primarily for tax reasons but for reasons of financial flexiblity.  From a research paper by Brav, et al.:

Many managers now favor repurchases because they are viewed as being more flexible than dividends and can be used in an attempt to time the equity market or to increase EPS.

David Berman at the Globe and Mail notes that Warren Buffett’s Berkshire Hathaway ($BRKB) is even buying back shares these days.  A recent Bloomberg article noted the surge in buybacks of late:

U.S. companies are buying back the most stock in four years, taking advantage of record-high cash levels and low interest rates to purchase equities at valuations 15 percent cheaper than when the credit crisis began.

The question is what to make of this.  The previous peak in share repurchases coincided with the prior stock market peak.  Therefore the discussion hinges more on market valuations than it does on the volume of share buybacks.

Maybe investors should focus less on the time-series of stock buybacks and more on the cross-section.  A recently launched ETF, the AdvisorShares TrimTabs Float Shrink ($TTFS) focuses on companies that are buying back shares with free cash flow as opposed to debt.*  If buybacks truly are a value-adding endeavor then this fund should have a good chance of outperforming.

In a certain respect this fund’s strategy represents the flipside of the surging demand for dividend paying stocks.  Baby boom investors reaching retirement are attracted to strategies that generate explicit income as opposed to potential capital gains.  Maybe for this reason the fund has yet to garner much more than $5 million in assets under management.  In any event the debate between dividends and share buybacks will continue and we will see whether the demand for dividend payers will win out over the boom in buybacks.

*No position in TTFS.

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