Stock Buy Backs, Good or Bad ??????

[frayne]

I didn't realize they were not allowed prior to 1980 de-regulation. I can see they might be attractive for the short run but long term will they become the straw that breaks the camel's back, again, reminiscent of the 2007-08 banking crisis ? Just curious what the collective here thinks ?

 

[jazz4cash]

Over-rated. It depends on what they do with the stock after they buy it back (if they ever actually complete the purchase after announcing the buy-back).

 

[Mdlerth]

Smarter people than me know things

Someone on this forum has a signature line that reads something like "Anything that can be used can be misused, and anything that can be misused will be misused."

I think it's an apt observation regarding stock buybacks.

 

[marko]

I've always been a fan of 'take the money and run'.

In this case, buyback the stock, let the price rise, figure it out in a year or two; there'll be some other slight of hand option for you.

 

[OldShooter]

The theory on buybacks is that it increases the market price of the remaining stock by making it more scarce, making EPS higher, etc.

Stock that is bought back can simply be extinguished or it can be held for use in employee incentive programs, etc. In the latter case, the corporations' temporarily holding the stock is a long-term non-event for shareholders and for the stock market price.

There is an argument that buybacks are a better way to distribute value to shareholders because it comes in the form of capital gains (and only when the stock is sold) instead of dividend income.

There is also an argument that top management does this because it increases the value of their stock options where dividends do the opposite.

It also can be argued that the money is going back to shareholders because management does not have profitable investment options for it.

Is that murky enough?

 

[joeea]

Over-rated. It depends on what they do with the stock after they buy it back (if they ever actually complete the purchase after announcing the buy-back).

I don't think I understand what you mean here.

If they buy back shares, what is it you imagine they do with the shares other than add them to the pool of purchasable shares?

If I own shares in a company, I'd be very pleased if they buy back all shares other than mine! $$$$$

 

[njhowie]

I don't think I understand what you mean here.

If they buy back shares, what is it you imagine they do with the shares other than add them to the pool of purchasable shares?

If I own shares in a company, I'd be very pleased if they buy back all shares other than mine! $$$$$

Generally, the shares are canceled - this is why remaining shares are more valuable. You have a pie being cut into fewer pieces. Some companies will take the repurchased shares, not cancel them, and add them to "treasury shares" - you will see this identified in the lower part of a company's balance sheet. The shares are no longer in the float, are still outstanding, and may be resold in the market at a later date to raise capital.

In general, there are a number of (big) issues with share buybacks.

1. Over the past few years, many companies have been issuing debt to have the cash to repurchase shares. The theory being that with interest rates low, it makes sense to issue the debt. The debt may be at an interest rate that is lower than the dividend yield - so using debt could be a good move. Additionally, interest paid on debt is tax deductible to the company. Personally, I don't think this should be allowed. Interest should be deductible only if the debt is for operational purposes - not financial engineering in repurchasing stock.

2. Companies which use cash to repurchase shares are essentially admitting that they do not have any operational use where they can get a better return. That's pretty sad.

3. Cash that is used today for repurchasing shares is cash that is not available tomorrow for operational purposes. How awful must it be to have a company you're invested in do big share repurchases when the shares are high, and then a few years later find themselves in bankruptcy? One of the best examples of this is Aeropostale. They did a $1B share repurchase at an average price of something around $16/share. As many folks know, it was just a year or two ago when they were filing for bankruptcy protection. Not that the ultimate outcome would have been any different, but certainly the company could have survived much longer and had more opportunities to turn things around if they had the $1B cash available as opposed to having repurchased all the stock and watched it go to $0. They torched $1B - and that was $1B of profits - no debt used.

4. More times than not, the companies are repurchasing shares not when they are low looking to take advantage of a period of weakness, but rather when the shares are high, and looking to keep them high. More times than not, when the buybacks end, the shares ultimately fall when the artificial demand is removed.

So, to summarize my view - buybacks get a lot of publicity and are most always called a good thing. However, the investor should consider the potential consequences of the company doing the repurchase and if they may be leaving themselves vulnerable if they go through a rough patch. Are the shares being repurchased to take advantage of the market not properly valuing the shares? Or is it the case that it is being done when the shares are at/near all-time highs looking to push them higher?

Tread carefully.

 

[audreyh1]

Companies that use profits to buy back stock but then turn around and issue incentive stock options to company management are just diluting stock for existing shareholders. This happened with a lot of high tech companies in the 90s and 2000s. You really have to look at stock issuance and executive compensation as well as buybacks.

Also, so many companies tend to buy their stock back when prices are high, then not have the cash to buy back stock when prices crater. Usually very bad timing. Seems like money flushed down the toilet. Poof!

So you really have to look at what the company is doing and what they have done in the past. They are not all bad actors.

 

[Clone]

I found them to be very confusing when inside the organization.


At one point in time, we were not allowed to run cost improvements that did pay back within 1 year. If it required 18 months to pay back the tooling, the change would not be considered. Internal ROI was calculated using an internal cost of capital around 12 to 15%. The famous SVA model said that if you did not return greater than that, you were destroying value. Basically, the cost of capital is quite high, and we can only afford to do projects that are all home-runs. Then the board turns around and buys back stock.


If a company has no opportunities for expansion, cost improvement, or new product development, then maybe it makes sense to buy back stock. To me, if the company doesn't have any prospects to use it's cash to improve it's business, then it makes that company stock unappealing to me. Owning indexes removes that part of contemplation.

 

[foxfirev5]

njhowies #4 observation is a sticking point for this simpleton investor. Buy high and through internal manipulation stick it to the outside shareholders. In most cases dividends are more straight forward with the value trap easier to identify. I admit some bias as these equities are held in tax deferred/tax free accounts so cap gains vs divies have no impact.

 

[pb4uski]

Generally, the shares are canceled - this is why remaining shares are more valuable. You have a pie being cut into fewer pieces. Some companies will take the repurchased shares, not cancel them, and add them to "treasury shares" - you will see this identified in the lower part of a company's balance sheet. The shares are no longer in the float, are still outstanding, and may be resold in the market at a later date to raise capital. ....

A nit, but treasury shares are not outstanding.... they are issued but not outstanding by definition... held in treasury. Outstanding refers to shares held by parties other than the company.

 

[GravitySucks]

All the problems NJHowie pointed out plus:

In the 90's I had a finance professor who published a paper on the use of buybacks as financial engineering those with large option positions would push for to increase their worth and how ripe for abuse this is. He had no proof of direct wrong doing, but pointed out s few certainly sketchy situation.
He also often bemoaned the drop in dividend distributions even back then.
What were once vices are now habits.

 

[HFWR]

Mostly good for management...

 

[Totoro]

Are the shares being repurchased to take advantage of the market not properly valuing the shares? Or is it the case that it is being done when the shares are at/near all-time highs looking to push them higher?

Pretty much this.

To be more explicit: a problem can lie within the executive compensation structure. If they get paid a bonus in function of the share price (options or otherwise), buying back stock means getting a free ride.

I love buybacks if done right because they are more tax efficient for me, and rather have capital returned than deployed inefficiently within a company.

 

[OldShooter]

This week's The Economist has a fairly thoughtful article on this subject.: https://www.economist.com/business/2018/06/02/six-muddles-about-share-buy-backs

 

[audreyh1]

Mostly good for management...

Exactly!

 

[Sunset]

The theory on buybacks is that it increases the market price of the remaining stock by making it more scarce, making EPS higher, etc.

Stock that is bought back can simply be extinguished or it can be held for use in employee incentive programs, etc. In the latter case, the corporations' temporarily holding the stock is a long-term non-event for shareholders and for the stock market price.

There is an argument that buybacks are a better way to distribute value to shareholders because it comes in the form of capital gains (and only when the stock is sold) instead of dividend income.

There is also an argument that top management does this because it increases the value of their stock options where dividends do the opposite.

It also can be argued that the money is going back to shareholders because management does not have profitable investment options for it.

Is that murky enough?

Buy backs also hide the dilution effect of stock option awards to management.

 

[Sunset]

Companies that use profits to buy back stock but then turn around and issue incentive stock options to company management are just diluting stock for existing shareholders. This happened with a lot of high tech companies in the 90s and 2000s. You really have to look at stock issuance and executive compensation as well as buybacks.

Also, so many companies tend to buy their stock back when prices are high, then not have the cash to buy back stock when prices crater. Usually very bad timing. Seems like money flushed down the toilet. Poof!

So you really have to look at what the company is doing and what they have done in the past. They are not all bad actors.

++++
I should have read further down before commenting, but this is exactly the problem/abuse of buy backs.

 

[Texas Proud]

Lot so negative opinions on this with some false IMO....


Let's take a look at Apple... it is generating a huge amount of excess cash... what to do with it? Well, they can dividend that cash to shareholders... it gives them added value but they have to pay a tax on it... Also, once a dividend is started people expect it to continue and to grow... (look at what is happening to GE when it looks like they might stop the dividend)...


So, how do you get rid of excess cash without a dividend... well, buy outstanding stock back... and when do you have excess cash? When the company is doing well... what happens to the stock price when a company is doing well? Yes, it goes up... so it is common to buy shares when the price goes up because the company is doing well...


So, this gets value to the shareholder as the stock price goes up because of the buyback... and without a taxable event unless the shareholder sells some shares...


A benefit of the buyback is that it can be turned on and off easily without the shareholders complaining... as mentioned, if a dividend is cut there it going to be an uprising..... not with a stop in buybacks...





I just took a look at Apple... they have bought about $33 billion of their shares the last 6 months... and they still have $45 billion laying around... which is over $25 billion more than 6 months earlier... they have to do something with all that cash....

 

[joeea]

Companies getting corporate tax cuts generally either bump their stock prices via buybacks, or invest the money in capital improvements.

Since this essentially is a short-term juicing scheme versus long-term plan, it's not surprising to see many take the "what have you done lately for me" route.

Most corporations these days (with few exceptions) operate on a quarter-to-quarter basis. Executives are rewarded for short-term gains, not for long-term investments.

 

[audreyh1]

Apple has done well with their buybacks and has also not diluted existing shareholders due to large stock options awards. Many tech companies have not done well, like HP, GE, CSCO and IBM.

 

[marko]

Mostly good for management...

Buy backs also hide the dilution effect of stock option awards to management.

Every company does it differently and it's not always what people think.

At least in my old company we had 30,000,000+ outstanding shares. As senior management, I might be awarded 5,000 shares per year as bonus and there were only four others who were so awarded.

Not sure that 25,000 shares made much difference to the share price.

A friend was awarded stock options as part of compensation at his company. Essentially he was able to buy blocks of the stock at discount but only during a very narrow exercise window.

So, while it looked like he had been awarded 10,000 shares, he might need to sell 8,000 to net 2,000.

People would say "oh, he made $500,000 on that stock award" but in fact after taxes he might pocket $70,000. Not bad, but not quite what you might think. Because of the narrow window and volatile price, he often had to let the option expire, so he'd get nothing.