Stock buybacks are projected to gain traction this year after slowing in 2023, fueled by forecasts of faster corporate earnings growth.

It begs the question: are stock buybacks good, bad, or something in-between? Below, I examine share buybacks: the pros, the cons, and the pitfalls.

Under a share buyback, a company purchases a certain number of its own shares. It may do this on the open market or by giving its shareholders the option to tender their stock to the company, usually at a slight premium to the market price.

The company then either cancels the purchased shares or holds on to them as “treasury stock” for possible reissuance. Either way, the stock repurchase reduces the total number of shares outstanding and gives each shareholder a larger economic slice of the company.

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.

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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.

A mountain of cash…

As the following chart shows, U.S. corporations are sitting on a lot of cash (latest available data):

Cash on hand has spiked higher in recent quarters and companies are itching to put that cash to use.

Here are three factors to keep in mind when assessing share buybacks:

• Share buybacks let you defer taxes.

That’s because you aren’t taxed on your gains until you sell your shares, while dividends are taxed in the year you receive them.

• Share buybacks give management flexibility.

Many investors view dividends as a promise, and any cut is likely to send them scurrying for the exits. Holding off on buybacks, however, isn’t liable to affect most investors’ view of the stock.

Many companies, in fact, never use all the funds their boards authorize for repurchases. This flexibility can be a plus if a company holds off on buybacks to pursue a new opportunity with strong potential, say, or make an acquisition that will boost its profits.

• Look out for companies that use buybacks to offset stock-based compensation.

This dilutes the effect of the buyback, because the shares the company is taking off the market are simply replaced by the ones it issues to management.

Many academics argue that stock buybacks really don’t increase a company’s intrinsic value. There’s an ongoing debate over which form of investor reward is better: dividends or buybacks. I side with those who favor dividends.

Dividend-paying stocks are proven tools for long-term wealth building, but they’re also safe harbors in rough seas because companies with robust and rising dividends also by definition sport the strongest fundamentals.

If a company has strong enough cash flow (and sufficiently low debt) to generate high and growing dividends, it also means that the balance sheet is inherently solid enough to sustain the company through uncertainty.

PS: Cryptocurrency is red hot right now. The “blue chip” of crypto, Bitcoin (BTC), gained 156% in 2023. BTC and the broader crypto market have embarked on a new bull market this year.

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John Persinos is the editorial director of Investing Daily.

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