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Last year - 2011 - I was writing short overview articles on stocks, covering the type of business with a light dose of analysis. I was doing the research and writing about up to 100 companies per month. One almost universal constant was that every company had some sort of ongoing share repurchase program on which to spend a significant chunk of the annual free cash flow. It seems like 99 out of 100 companies had an aggressive repurchase authorization - and action - in place. Any time I see almost universal acceptance of a specific practice or tactic, I start to think about the potential downside.

Share buybacks, along with paying dividends, are the two choices available when a board of directors wants to pay out profits or cash to investors. Investors like dividends because it puts cash in their pockets. Corporate management groups like buybacks because buying back shares makes the company's per share results look better going forward.

For example, I will use Hewlett-Packard (HPQ) because they reported earnings yesterday. The HP share count has decreased by almost 200 million shares or 9% of the float. If the company had not bought all of those shares, the net income per share announced Wednesday would have been 73 cents instead of the 80 cents reported.

Here are a few reasons why I think the widespread use of share repurchase authorizations is a bad idea:

It's laziness by a corporate board of directors. The folks running these companies know the Wall Street analysts love buybacks - makes their models easier - and the corporate management does not have to figure out how to make a few hundred million to several billion dollars work productively for shareholders. The business is running fine. Management can grow sales and earnings by an acceptable percentage each year and buying back shares makes the numbers look good. Why go to any extra effort to make the business even more profitable?

It's bad for the U.S. economy: I believe one reason the employment situation in the U.S. is so stagnant is because the major corporations would rather use excess cash to buy shares rather than spend that money on growth initiatives which would probably require the hiring of significant numbers of new employees. If almost every large publicly traded company in America is buying shares rather than hiring employees, what is the overall effect on total employment? Note that Hewlett-Packard also announced a restructuring Wednesday which includes 27,000 employees losing their jobs. The stock market loves this stuff - in the short term.

Buybacks stifle innovation and growth. Returning cash to investors has become a boardroom mantra which appears to have replaced 'how do we make our business grow to reward shareholders'. There is something profoundly wrong when almost every company in America chooses to buy back its own shares rather than try to find ways to invest that money in the business to increase profitability. There is risk involved with the second option and avoiding risk seems to be the mainstream choice.

The next time you listen to an earnings report and the corporate management touts the company's share buyback program, ask yourself: Do I want to invest in a company which cannot find a better way to put this money to work?

Source: The Problem With Share Buyback Authorizations