In the realm of quotable quotes, iconic investor Warren Buffet is in my opinion the crème de la crème. Buffet, now 92 years old, emits the wisdom of free enterprise like Yoda himself, often providing the most candid, crustiest and funny material an investor could ask for.
My most favorite recent quote involved the practice of corporate management repurchasing their own stock, known succinctly as stock “buybacks.” This activity has been much maligned by left-leaning politicians during the on-going ESG (Environment, Social and Governance principles) distraction that we have discussed on prior occasions in the column.
Buffet obviously has different opinions on the subject and managed to sum them up perfectly with a recent assertion saying, “When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue, characters that are not mutually exclusive.”
The first answer is fairly straight forward. Profitable corporations by their very nature create what is called free cash flow. While not all declared earnings, or profits, are comprised completely of free cash flow, this type of net profit is generally the result of profitable operations and is considered clear of any internal or external financing operations. Or in other words, it’s the cash a company gets to keep.
Corporate management, including corporate boards of directors, are charged with deciding what to do with free cash flow. They can choose to reinvest the cash in corporate operations such as facilities, marketing, wages, product development or acquiring other companies, they can choose to pay it as dividends to shareholders, they can use it to reduce debt or they can decide to use it to buy their own stock in the marketplace, essentially “retiring” the shares.
When the shares are repurchased or retired, future profits will be shared among fewer outstanding shareholders, which by its very nature increases the amount of profits per share, which should in turn create more demand for the company’s stock, leading to a stronger stock price. In addition, the act of buying the shares back in the open market creates an inherent demand for the company’s stock and should again lead to a stronger stock price.
If we understand the purpose of a corporate board of directors is to represent the interests of the company’s owners, aka the stock holders or investors, and the purpose of corporate management is to manage the company in the interest of all stakeholders, such as investors, customers and employees for the ultimate benefit of the owners, the shareholders, we can see why the potential benefits from stock buybacks would look like an attractive decision for how to handle free cash flow. Or said simply, buybacks help the stock go up, and that makes investors happy.
The fuss comes in when we start to explore the political left’s view of the purpose of a corporation. With the advancement of ESG principles, a concerted effort is underway to alter the way a corporation is perceived, from something being purposed to create wealth for its investors, to a more multifaceted role of serving society according to a set of external standards set not by investors, but rather the ESG movement’s definition of the greater good. So, in essence, under this philosophy, the free cash flow created by profitable operations doesn’t necessarily belong to the company’s investors, but rather it belongs to society as a collective.
Now, we could debate all day which corporate purpose — creating wealth for investors or serving society — sounds better, but our debate would be irrelevant. Legally, ethically and operationally, corporate boards and some management serve as a fiduciary to the company’s investors. This means they are obligated to act in the best interest of shareholders, period.
Sometimes this means reinvesting profits in facilities, employees or products. Sometimes this means paying profits as dividends or buying back stock to help influence share prices higher. Never does it mean subordinating the interests of investors to the external priorities of politicians or activists. Never.
If politicians like Elizabeth Warren and Joe Biden, wielding temporary influence, want to change the long-standing legal purpose of a publicly traded corporation, our Constitution has a process for that, and they should attempt to use it. But before anyone takes a knee-jerk reaction to kill this golden goose, we need to remember that no wealth in America is created without some sort of free enterprise, and free enterprise is funded by investors. If prosperity for as many as possible is the goal, which of course it is, I will choose wealth creation through investment over the subjective interests of activists and politicians any day of the week and twice on Sunday.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at email@example.com. Securities offered through LPL Financial, member FINRA/SIPC.