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Meb Faber Beats Down Stock Buyback Myths
Portfolio > Economy & Markets > Stocks
By Jane Wollman Rusoff
September 06, 2022 at 03:49 PM
Stock buybacks aren’t the “bogeyman” that many politicians and economists mistakenly portray them as: “They’re a phenomenal tool for investors [and] essentially flexible dividends,” argues Meb Faber, co-founder, CEO and CIO of Cambria Investment Management, in an interview with ThinkAdvisor, wherein he rebuts buyback myths.
Faber has been focusing on the positive aspects of share repurchase for years. Indeed, three of his RIA’s 12 exchange-traded funds are based on the concept of cash returned to shareholders for dividends and net buybacks.
All three of those value funds have four- and five-star Morningstar ratings, he notes.
In the interview, the longtime popular blogger and twice-weekly podcaster, host of “The Meb Faber Show,” maintains that companies aren’t repurchasing their stock as a way to boost top management’s compensation — a myth that many believe, he says.
Nor does he think that buybacks “magically make stocks go up” — another myth, Faber underscores.
As for the 1% excise tax on buybacks for companies that is part of the Inflation Reduction Act, he emphasizes that buybacks are already taxed twice.
“Taxing [them] a third time is obviously insane!” he declares.
Stock repurchasing has been around since Alexander Hamilton’s day, according to Faber.
“Trying to disincentivize companies from buying back their stock is crazy,” he says. Without share repurchase, CEOs would probably deploy their firms’ excess cash in “some sort of megalomaniac-style spending.”
A frequent industry speaker, the quant and former biotech analyst launched his RIA near Los Angeles in 2005.
A prolific author of books and white papers, Faber’s most recent tome — a sequel of sorts — pulls together insightful essays on investing: “The Best Investment Writing — Vol. 2: Selected Writing From Leading Investors and Authors” (2018).
Faber recently spoke with ThinkAdvisor by phone from Manhattan Beach, California.
He holds that “removing the buyback corporate feature would have the opposite effect of what politicians think.”
Here are excerpts from our conversation:
THINKADVISOR: Why are buybacks so controversial?
MEB FABER: It’s certainly a curiosity why politicians have glommed onto buybacks.
In trying to close the wealth and income gap in this country, a lot of them and others point out that company CEOs have [huge] pay packages. Whether it’s through salaries or options, they get paid a ton of money.
There’s a belief that this has something to do with buybacks. It doesn’t. It has to do with the boards setting really crazy C-level compensation.
But many [critics] have the belief that — instead of paying employees higher wages or hiring more people — what CEOs are doing with all that cash they have sitting around is buying back their stock, which is going to be beneficial to management.
There are a couple of problems with that line of thinking.
Also, there’s a false belief that buybacks are less than legal. That was never true. However, people repeatedly [say that it is].
What are your thoughts about the 1% excise tax on buybacks for companies that’s part of the Inflation Reduction Act?
Dividends and buybacks are already taxed twice: when the company makes money and again when the investor receives payment.
Taxing buybacks three times is obviously insane!
How do buybacks affect earnings or the value of a stock?
A lot of commentators say CEOs are buying back stock and doing financial engineering to try to raise earnings per share so they can hit higher compensation levels. That’s a myth.
Buybacks do have an effect on earnings per share, but [a board’s focusing on them] for a compensation scheme would be horrible.
What do companies typically do with their cash?
Five things: reinvest it in the business, acquire a competitor, pay down debt. And if you have a bunch of cash sitting around, you can return it to the shareholders through a dividend or a buyback.
The weird part is [politicians] wanting to disincentivize companies from buying back stock. That’s crazy. If you do, the CEOs will just have more cash sitting around. They’re not going to pay workers more.
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What would they do with the excess cash?
Left to their own devices, they would probably take that cash and do some sort of megalomaniac-style spending: pay themselves more, buy jets, go to the Masters, name a stadium.
Investors are likely confused about buybacks. They don’t know if they’re good or bad. Your thoughts about that?
It’s as if buybacks are the bogeyman. But they’re a phenomenal tool for investors.
Buybacks are essentially flexible dividends: When a quarter comes around, [the investor has a choice]: Do you want some cash back? If you don’t, you’re going to own a higher percentage of the business.
If you do, [the company] will buy [back] some of your stocks.
What would happen if buybacks weren’t permitted?
You want a company that’s cheap, that has great earnings but with the CEO held in check and who treats shareholders with respect.
Removing the buyback corporate finance feature would have the opposite effect of what politicians think.
If you want to make buybacks go away, lose the tax on dividends. Just say, “We’re not going to double-tax dividends.”
And all of a sudden, there’s no problem with companies returning cash to shareholders.
But then there’d be complaints that they’re returning too much.
To what extent are buybacks responsible for the stock market’s going up?
I don’t think it has any effect on that. I don’t think that buybacks magically make stocks go up.
When a company pays dividends, the vast majority of them get recycled by people reinvesting them in the rest of their portfolio.
It’s the same thing with buybacks. The company buys the stock, but someone [has to] sell it. So it’s a net zero effect.
What do you think of Warren Buffett’s affinity for buybacks?
During [the first months of] the pandemic, I said, “After all this settles, my guess is that he [will] buy back a ton of Berkshire.”
And that’s what happened [He repurchased a record level May-June 2020]. Charlie Munger [Berkshire Hathaway vice chair] loves buybacks.
What’s your outlook for the stock market?
We’re quants: We follow our models.
My belief is that the U.S. stock market is very expensive. We expect that stock returns will be much lower over the next decade than they have been.
So we’re fairly bearish on broad market cap U.S. stocks.
The good news is that we think value stocks will do just fine. The other good news is that foreign and emerging [markets] stocks relative to the U.S. are much cheaper.
We think they’ll do just fine too.
Where do you stand on the question of an impending recession or one that’s already upon us?
The yield curve inversion [long-term interest rates fall below short-term rates] usually has a pretty good track record of predicting recession.
The yield curve [has now inverted].
[Well], that’s my favorite indicator.
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