As the global economy rebounds, companies are preparing to launch a record wave of buybacks. Buybacks have become a global phenomenon over the past 20 years, with many companies viewing them as an attractive alternative to dividends in returning capital to shareholders. They are flexible, recycle excess cash to the economy, and provide tax advantages in certain jurisdictions.

While buybacks can indeed be an effective way to distribute capital under certain circumstances—and can be used to signal to investors that their stock is undervalued – care must be taken to mitigate the downsides of buying back shares.

Common pitfalls

As tempting as buybacks may be as a quick way to return funds to shareholders, there are several pitfalls to consider.

From a strategic perspective, timing a buyback poorly can lead to losses. Companies cannot perfectly predict the market and often buy at market peaks, rather than troughs, due to overconfidence. This is also the tendency when the firm is generating excess capital. It can be mitigated by taking a long-term dollar-cost averaging approach to buybacks, adjusting the strategy based on market conditions and adopting a break-even scenario analysis.

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