Buybacks vs. Dividends: A Moot Point

Monday's Wall Street Journal contained an instructive article entitled "Corporate Buybacks Test Concept of Value," in its Heard On The Street column.

The proposition of the piece was that share buybacks, meant to boost earnings per share by cutting the denominator of shares outstanding, are merely a gaming tool for corporate executives to manage EPS.

The article's author, Liam Denning, then argues that dividend payments enforce better financial discipline.

To me, these points are moot.

Denning cites stock buybacks of $1.4 trillion among S&P500 companies between 2005 and 2007.

What this tells me is that these firms failed to find adequate investment opportunities. My proprietary performance research indicates that consistently superior firms add employees, capital and expenses over time. They don't shrink their capital base.

Perhaps it is my focus on fundamentals which leads me to ignore EPS. Years of corporate management positions taught me that what can be gamed, probably will be gamed. Thus, any performance measure with a controllable term in a ratio is suspect.

Total return is a ratio of two market values. EPS is the ratios of two controllable (by management) values- one from the income statement, the other from the balance sheet.

Among the companies Denning mentions in his piece are GE, Lehman Brothers, Exxon Mobil and AIG. None of which I have owned.

Back when I was in graduate school for business, we were taught that dividend policy didn't matter. If anything, as the Chicago School determined, taxes made dividends less preferable than leaving it on the firm's balance sheet, to be invested in operations.

To argue whether buybacks or dividends are better for 'financial discipline,' in my opinion, misses the point.

Why invest in a company that is signaling that it isn't growing? That is literally returning capital to owners and shrinking?

My original research further revealed that growing firms had a greater chance of consistently outperforming market average total returns, and by a greater margin, than slow- or non-growth firms.

Knowing that, why would an investor even want to own a firm that is publicly marking itself as a less-capable firm, in terms of market outperformance?