• Warren Buffett has touted the value of stock buybacks for decades.
  • US lawmakers want to pass a coronavirus stimulus bill that temporarily bars companies that receive government bailouts from buying back their stock.
  • “Discussions about share repurchases often become heated,” the famed investor said in his 2016 shareholder letter. “Some people have come close to calling them un-American – characterizing them as corporate misdeeds that divert funds needed for productive endeavors. That simply isn’t the case.”
  • Here are five reasons why the Berkshire Hathaway boss is a lifelong fan of buybacks.
  • Visit Business Insider’s homepage for more stories.

Warren Buffett has trumpeted the value of stock buybacks for more than 50 years. Yet US lawmakers, as part of a potential $2 trillion coronavirus relief package, plan to ban companies that receive government bailouts from buying back their stock for the duration of the assistance plus one year, Bloomberg reported.

The famed investor’s stance came under fire this month after Bloomberg estimated that the five biggest US airlines splurged 96% of their free cash flow on buybacks over the past decade, and The New York Times reported they spent north of $19 billion repurchasing shares in the last three years.

Despite their splurges, Airlines for America recently requested up to $50 billion in government grants and loans to help the industry as coronavirus fears and transportation halts continue to decimate demand.

Critics blasted the airlines and other distressed businesses for spending billions repurchasing their shares and then demanding to be rescued, accusing them of enriching their shareholders at taxpayers’ expense.

"If there is so much as a DIME of corporate bailout money in the next relief package, it should include a reinstated ban on stock buybacks," Rep. Alexandria Ocasio-Cortez tweeted this month.

"Any public company that receives a bailout or significant funding should not be allowed, by law, to do stock buybacks EVER AGAIN as part of their agreement," billionaire Mark Cuban tweeted last week.

The bad press strikes a stark contrast to Buffett's strident defense of sensible stock buybacks.

"Discussions about share repurchases often become heated," he said in his 2016 letter to shareholders. "But I'd suggest that participants in this debate take a deep breath: Assessing the desirability of repurchases isn't that complicated."

"Some people have come close to calling them un-American - characterizing them as corporate misdeeds that divert funds needed for productive endeavors," he added. "That simply isn't the case."

Here are five reasons why the billionaire investor and Berkshire Hathaway CEO is a lifelong fan of the controversial tool.

1. Shareholders benefit

Foto: Source: Truth Leem/Reuters

Buffett and his partner, Charlie Munger, argue that stock buybacks can be hugely beneficial to shareholders in the right circumstances.

"Charlie 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," Buffett said in his 2011 letter to shareholders.

The first condition rules out a company with more pressing needs from irresponsibly spending its cash on buying back its shares.

The second condition simply means that shares are trading at a reasonable price, and are therefore offer an attractive entry point for the stock purchases.

"Disciplined repurchases are the surest way to use funds intelligently: It's hard to go wrong when you're buying dollar bills for 80¢ or less," Buffett said in his 2012 letter.

Slashing the share count also boosts each shareholder's stake in the business. Buffett used Apple, Berkshire's biggest holding, as an example at the conglomerate's annual meeting in 2018.

"I love the idea of having our 5%, or whatever it may be, grow to 6% or 7% without us laying out a dime," he said, according to a transcript on Sentieo, a financial research site.

Back in the 1970s, before buybacks became "all the rage," Buffett "searched for companies that were large repurchasers of their shares," he said in his 1999 letter.

"This often was a tipoff that the company was both undervalued and run by a shareholder-oriented management," he added.

2. Sellers benefit too

Foto: Source: REUTERS/Jim Young

Buybacks are good for sellers as well.

"From the standpoint of exiting shareholders, repurchases are always a plus," Buffett said in his 2016 letter. "It's always better for a seller to have an additional buyer in the market."

However, Buffett emphasized in his 1999 letter that executives should give their shareholders all the information they need to fairly evaluate their companies so they don't take advantage of any sellers.

3. Executives can show they prize shareholders

Foto: Source: REUTERS/Rick Wilking

Executives can buy back stock to show that they're prioritizing shareholders' interests, which can boost their companies' share prices.

By snapping up undervalued shares, "management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management's domain but that do nothing for (or even harm) shareholders," Buffett said in his 1980 letter.

"Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business," boosting the company's share price towards its intrinsic value, he continued.

"Investors should pay more for a business that is lodged in the hands of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer," Buffett added.

4. Acquisitions are riskier

Foto: Source: Chip Somodevilla / Getty

Buying shares is a lot safer than buying businesses.

"Acquisitions are similar to marriage: They start, of course, with a joyful wedding - but then reality tends to diverge from pre-nuptial expectations," Buffett said in his latest letter to shareholders.

"It is usually the buyer who encounters unpleasant surprises," he added.

Buffett struck a similar chord in his 2014 letter.

"You can't get rich trading a hundred-dollar bill for eight tens," he said.

Munger echoed Buffett's comments at Berkshire's meeting in 2018, declaring that many companies that make acquisitions are often "worth less after the transaction is made than they were before," according to a Sentieo transcript.

In contrast, Buffett has expressed great confidence in the value of buybacks over the years.

"No alternative action can benefit shareholders as surely as repurchases," he said in his 1984 letter.

5. Dividends are less efficient

Foto: Source: Bill Pugliano/Getty

Buybacks are a more cost-effective way to return money to shareholders than dividends.

"Instead of repurchasing stock, Coca-Cola could pay those funds to us in dividends, which we could then use to purchase more Coke shares," Buffett said in his 1999 letter.

"That would be a less efficient scenario," he continued.

"Because of taxes we would pay on dividend income, we would not be able to increase our proportionate ownership to the degree that Coke can, acting for us."

Not all stock buybacks are equal

Foto: Source: Paul Morigi/Getty Images for Fortune/Time Inc

In Buffett's book, buybacks are inappropriate if they don't satisfy Berkshire's two conditions.

If a company needs its cash to maintain or expand its operations, and it doesn't want to take on debt, repurchasing its shares wouldn't make sense, the investor argued in his 2016 letter. The same is true if there's a more attractive acquisition or investment opportunity available.

Nor do buybacks make sense if the stock isn't undervalued, Buffett said.

"It doesn't suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash," he said in the letter. "Continuing shareholders are hurt unless shares are purchased below intrinsic value."

"The first law of capital allocation ... is that what is smart at one price is dumb at another," Buffett added.

Management's motives also matter.

If executives buy their companies' stocks solely to pump up the prices, that is "insane and immoral," Buffett said at Berkshire's annual meeting in 2018.

Some bosses repurchase shares to "show confidence" or "be in fashion," not for the sake of shareholders, he said in his 1999 letter.