In an appearance earlier this year on CNBC, U.S. Senator Elizabeth Warren (D-MA), an outspoken progressive, excoriated stock buybacks as “nothing but paper manipulation” that’s bad for investors and the economy.

A new report on stock buybacks, released Monday, begs the question: are stock buybacks good, bad, or something in-between? Below, I examine the pros and cons.

The record surge this year in stock buybacks reflects the enormous liquidity sloshing around in the financial markets, and that’s a bullish dynamic.

That said, stocks eased back Monday from their record highs, as investors nervously eyed the forthcoming Federal Reserve meeting. The major U.S. stock indices fell as follows: the Dow Jones Industrial Average -320.05 (-0.89%); the S&P 500 -43.05 (-0.91%); the NASDAQ -217.32 (-1.39%); and the Russell 2000 -31.31 (-1.42%). In pre-market futures contracts Tuesday, stocks were extending their losses.

Buybacks are at record levels…

After a brief retreat last year, stock buybacks have rebounded to their pre-pandemic levels and they’re on pace in 2021 to hit record levels.

Research firm Statista reported on December 13 that S&P 500 companies in aggregate repurchased $234.5 billion in shares in the third quarter of 2021, exceeding the previous record of $223 billion set in Q4 2018, which previously had been the most active year for stock buybacks (see chart).

Heightened stock buyback activity helped financial markets climb out of their COVID-induced slump, and has since served as a major pillar of the bull market.

Last Friday, the S&P 500 index posted its 67th record close this year and it’s up more than 25% year to date.

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The surge in stock buybacks is a global phenomenon. Dealogic reports that companies around the world ponied up $68 billion through corporate buybacks between January and November in 2021, a three-year high.

Stock repurchases lift share prices in several ways. They reduce a company’s share count, thereby limiting supply and boosting per-share profitability. They also enhance investor sentiment, because they suggest that management is confident about the company’s prospects and feels the share price has much further to run.

But buybacks have their drawbacks, too. They siphon funds away from corporate investments that can nurture future organic growth. Critics also argue that they’re a way for top executives to boost the value of their stock options, at the expense of the long-term health of the company.

Buybacks also muddy the earnings picture. Because a share repurchase reduces shares outstanding, it increases earnings per share (EPS) and tends to raise share prices. Accordingly, stock buybacks can hide a company’s true earnings growth by showing an attractive increase in EPS, while the profitability might really be flat or declining.

Buffett’s view on buybacks…

Warren Buffett has weighed in on when it makes sense for a company to buy back its shares. In a 2011 letter to Berkshire Hathaway (NYSE: BRK.A, BRK.B) shareholders, Buffett stated:

“Charlie [Munger] and I favor repurchases when two conditions are met: First, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.”

Investors need to think longer term about the return they may or may not receive from buybacks. If the price of the stock sinks after the company buys back its shares, that’s not a very good use of that cash.

Also keep in mind, a buyback announcement is non-binding. Just because a company says it has approved a program to potentially use a specific level of funds to repurchase shares doesn’t mean it will follow through. And even if the company does execute the repurchase plan, it may not be the company’s best use of the cash.

Most companies do not publicly announce when the buyback is actually occurring. Only after the end of the quarter do investors know how much stock, if any, was repurchased and at what price.

The upshot: Don’t make investment decisions solely based on a company’s buyback plans.

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John Persinos is the editorial director of Investing Daily. To subscribe to John’s video channel, follow this link.