Tech earnings featured more stock buybacks – here's what that means for investors

Share repurchases, or stock buybacks, have appeared over and over in tech companies' earnings this year. But they might be misunderstood, according to Cornell University assistant professor Nick Guest.

"Our main takeaway is that share buybacks don't create or destroy a lot of wealth," Guest told Yahoo Finance Live (video above). "So you might wonder, 'Well, why are companies repurchasing on track for more than $1 trillion this year?' The benefits seem to be an opportunity for management to signal that they believe the stock is undervalued."

There are plenty of criticisms of buybacks, including that companies use them to manipulate their share prices. But those criticisms haven't been necessarily proven by the data, according to Guest.

"Some argue they're associated with excessive executive compensation and that companies that buy back don't have as much cash available to take advantage of investment opportunities, thereby sacrificing growth and ultimately profitability," he said. "But our evidence comparing both companies that repurchased and companies that don't repurchase shares didn't find any large-scale, on average, evidence of those things."

Some of the biggest buyback news of this earnings cycle came from Alphabet (GOOG, GOOGL). If Google's $70 billion buyback announcement seems big, it is — sort of, VerityData analyst Ali Ragih said.

"$70 billion is slightly large for them, but not when you compare and adjust market-wide," he said. "The best way to think about $70 billion is to compare against the market cap because you can better normalize market-wide. $70 billion is equal to 5.2% of the market cap at Google."

Likewise, Apple (AAPL) also announced it would buy back $90 billion in stock this week.

Why companies buy back stock – and when they should

So why do these companies do stock buybacks?

"Repurchases have more flexibility than dividends," Guest said. "They're easier to temporarily cut during downtime, and repurchasing shares reduces the amount of cash that could be misused on management's pet projects."

Another reason, Guest added, is that "managers and others — the board, for example — can use repurchased shares to compensate employees. So those seem to be the benefits, as opposed to improving long-term profitability or creating additional investment opportunities."

It's worth doing buybacks when management thinks the company's valuation is low, Ragih said.

"The best time to do a buyback is when the valuation is low because companies get the most bang for their buyback," he told Yahoo Finance. "If Google spends $15 billion, they’d want to get the most amount of shares for that $15 billion – lower stock price will get them more shares for the same overall dollar value of spend."

It's even more worthwhile if the company in question has the cash, which Alphabet does, Ragih added.

"Google has a high amount of free cash flow and not much else to spend it on, so it’s appropriate to return cash to shareholders," he said. "To boil it down, after they pay for organic investments, they still have a lot of cash left each quarter. The cash balance is about $100 billion so they defer to buybacks."

However, buyback backlash has increased in recent years. Critics say that they enrich companies and executives without improving the overall economy. So over time, shareholders may see fewer buybacks if that trend continues.

"If the disincentives increase — for example, if we get this 4% tax or other limits on what managers can do in terms of selling their own shares after the company has bought back shares, and other potential restrictions — then some firms might decide to retain the cash instead or switch to dividends, which both could have negative consequences," Guest said. "For example, dividends, as we know, are taxed as income tax, ... whereas repurchases typically generate a capital gain. So that could create some additional costs for shareholders."

Allie Garfinkle is a Senior Tech Reporter at Yahoo Finance. Follow her on Twitter at @agarfinks and on LinkedIn.

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