Why I Don't Like Stock Buybacks
avc.com
avc.com
Cash for investors? But doing nothing for the company? That's a good thing and more companies should do this.
The sole purpose of the company is [1] to increase shareholder value. If reinvesting in the company would bring above-market returns, then it's a good idea to do. If not, corporate leadership should increase shareholder value with cash rather than building an empire with other people's money.
[1] I ignore nonprofits and corporations with special clauses in their charter.
Also, a share buyback signals to investors that the company believes its shares are undervalued.
It is possible for a more mature company to have truly reached market saturation in their area. Then they are left with the option of investing in R&D to try to make something truly new, trying to branch out outside of their current area, or distributing the profits to shareholders.
These three stategies are not mutually exclusive and a company with sufficient profits can do all three. But both R&D and diverisifying can involving risking the money put into them (potentially even more than you put into them when you consider liability possibilities), so it can make a lot of sense for a mature company to directly enrish the shareholders, and a stock buyback is one way of doing that.
The root of all evil, right there.
I prefer companies whose sole purpose is to act as an engine of change for a better world. Even Drucker's (?) "sole purpose of a company is to get and retain customers" is better.
My real problem with your quote (from Friedman is it?) is that when a majority, or even a vocal and persuasive minority, or people adopt that attitude it throws out a lot of the social constraints in place to keep people running the companies from doing things that harm us as a society. That is, "he was just acting in his own best interest" can be used to justify many acts that are selfish and short-sighted, because there are no social consequences of this. Even people of high personal moral standards are willing to give a pass to evil deeds because "he did what he had to do."
I disagree.
I wouldn't go as far as to say "root of all evil", nor do I think it's a companies responsibility to "make the world a better place" per se but "increase shareholder value" does usually end up meaning "current shareholders". That is, it seems to lead to short term gains at the cost of the long term.
The only reason not to buy back shares if they're trading below tangible book value [1] is because you have investments available that will yield greater returns, or do not have sufficient cash to do so.
[1] Factoring in a margin of safety, of course.
His point is that companies that can't find better ways to use capital than a buy back aren't innovative enough to succeed in the long term
Stock buybacks are very popular with some investors as a way for a company to transfer value from the company back to the shareholders. It is like a dividend, except it is taxed as a capital gain, not ordinary income.
He's approaching it from the opposite direction; ie returning value to investors who are selling their stock. But if the company is truly worth more per share, in terms of tangible book value, than the price the shares are trading at then anyone who is selling up is getting a bad deal. These people aren't getting value. It's the people who retain their stock who are getting value because they're managing to buy slices of a company worth $(X+Y) for only $X.
A simplified example:
FictionCorp has $200 million in the bank and 100 million shares outstanding. For some reason, the shares are trading at $1, despite the $2/share sitting in the bank.
If FictionCorp manages to go and buy back half its stock at $1/share, it now has $150 million in the bank but only 50 million outstanding shares. Each share now represents $3 worth of cash in FictionCorp's bank account.
Hence, the remaining stockholders are better off because they've managed to buy a larger portion of FictionCorp at a discount to its actual value.
Go buy shares at $1.01 during the buyback (people will sell to you rather than FictionCorp, since you are the best bidder), then sell them at $3.00 after the buyback is finished. This is a moneymaking opportunity whenever the share price is below $2.00.
Come back when you are rich and I'll believe you found an inefficiency in the market. Until then, I think you are wrong.
If you believe markets are always efficient[2] then I ask you to explain the tech crash in 2001. The NASDAQ lost 78% of its value over two and a half years and is still down ~60% from its peak.
[1] Of course if you don't have control over the management and they're spending profligately enough to eliminate the advantage you wouldn't invest. Fred Wilson was the Chairman, however, so that was a non-issue.
[2] They are mostly efficient, but at times human psychology causes them to be over or undervalued, ie during bubbles or after crashes.
Buybacks work in theory, but they depepnd on a lot of factors.
Essentially what you are trying to do is shrink the existing share count, so that EPS goes up which presumably drives your share price up in the longer term.
E.g.:
$10 in net income / 10 shares = $1 EPS. Lets say right now you are trading at a 6x multiple, the market is nervous about your prospects. You think your shares are undervalued and that you are probably worth 10x (perhaps your industry average).
So you buyback 20% of your shares, existing share count decreases from 10 to 8. EPS goes up to $1.25 per share.
But, one of the uncertainties behind a buyback is the fact that you never know when or how much management will actually buyback. They will sometimes announce a plan that would buyback 20% of shares, but only do that over maybe 10 years. Thats why your bit about timing the buyback just doesn't work.
Let's say somehow you do manage to buyback the 20% in just one year (the market hates your company). So with an EPS of $1.25, if the market keeps giving you that 6x multiple, in theory your shares should be worth at least $7.50, not the $6 before. Moreover, if the buyback signals enough confidence in the company, maybe the market will realize it and you will return to the 10x multiple you had before, so your shares go to $12.50
But see nobody can time when the market works or when the market will catch on to the value of your company. Benjamin Graham said that is one of the great mysteries of the stock market when he testified before congress.
It is during that lag time when the share price does not move that investor confidence can waiver and maybe they will sell -- ultimately not realizing the value that eventually comes from the buyback and reduced share count.
I don't know where you get that idea. I work for a hedge fund, which would be really dumb if I believed markets were efficient. That would mean my expected bonus is $0 [1].
When a rich person tells me "markets were inefficient, and now I'm rich", I often believe them. When a person tells me "look, a whole bunch of idiots are throwing their money away, but I'm not going to take it off their hands", I'm a little skeptical. And when someone says "look, the markets are inefficient in a manner that is extremely obvious and easy to exploit", I'm also a bit skeptical, since most such inefficiencies have already been arbed away.
Lastly, my trading strategy doesn't require the buyback to complete. All it requires is that philk's claim actually occurs: that the buyback transfers money from sellers to shareholders. Using his numbers and my proposed buy price of $1.01, the moment the buyback has transferred at least $0.02/share from sellers to shareholders, the strategy has become profitable.
[1] Not strictly true, since a bonus behaves like a call option on profits, but you get the picture.
If you're buying a dollar bill for 90 cents, and someone offers you a dollar bill for 80 cents, you didn't lose money.
I disagree with this post. If TSCM was trading at less than net cash, a buyback meant that they were getting paid to own more of it. That's an incredible deal. Also, they did something that would gave the business a temporarily negative market value (i.e. cash plus business is worth less than cash alone)--and they thus should have invested more cash in the business? That doesn't make sense.
Either the stock market was right, TSCM was worth liquidation value, and the buyback was a way to gradually liquidate the company... or the market was wrong, the TSCM business was worth more than the stock's market price, and buying back the stock was a great move.
> I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down.
It seems to me that if your stock is trading at under book value, then you would be underpaying if you are buying it. Especially if it keeps going down.
Isn't the idea that the stock is undervalued? Why not buy low now and even consider selling high at a later date?
It's not necessarily not good.
I guess obviously if a company does a buyback but the stock goes down for unrelated reasons then you're really not gaining anything.
That's exactly what a dividend would do.
Silverlake is correct to point out that this doesn't apply to small investors, however.
The author may have a point that he was signaling they had nothing better to do with the funds. But, it's hard to say the share price would not have been worse, since this happened in a downtrending market. There is a potential confounding fallacy in that the author doesn't seem to get.
Unless they held the stock above the falling trend. I felt this was a potential flaw in the analysis - the stock price kept falling but that was not necessarily related and could have crashed completely if it weren't for the buyback, we can't tell; it's not science.
I like dividends for mature cash flowing businesses who cannot find a good use of their cash
Fred
They could also greatly improve their web browser. Apple's devices totally eat RIM's lunch when it comes to browsing.
Obvious exaggeration. How many companies have more cash than market cap? Only ones that owe the money to someone else and cannot use it to buy back their stock. That made me question the whole article.
It doesn't seem that implausible after a stock market crash.
It used[1] to happen a bit more often because information wasn't as readily available.
[1] ie decades ago...
They are sort of an inefficiency. In one sense, you are buying a stock for less than the cash on balance sheet. You could come in and liquidate it, making a profit.
On the other side, sometimes stocks trade at negative EV because management is doing some terrible things. Maybe they are burning through cash at an alarming rate. Sometimes an activist will come in and stop the cash burn.
I would also like to add that you can find negative EV stocks abroad more readily. There was a period when these opportunities existed in Korea (I think around 2004). It was pretty amazing if you were an investor.