In theory, buybacks can create more aggregate wealth than dividend payments because ordinary dividends get taxed at income tax rates while stock repurchases evade the reach of Uncle Sam. And the effectiveness of a stock buyback program is contingent upon the corporate management team getting the valuation. If you buy back stock when it’s cheap, you create value. If the stock is expensive and you repurchase stock, then you destroy value. That is why I have a special respect for Warren Buffett’s commitment to only repurchase Berkshire shares when it trades 1.2x book value or less–it is an implementation of the valuation requirement that is a necessary prerequisite for stock buybacks to create wealth.
Generally, the corporations that are most naturally suited to run successful buyback programs are those with large cash hoards, cheap access to borrowing, and/or stable cash flows even at the low points of the business cycle. … Read the rest of this article!