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Do Share Buybacks Create Value? (Spoiler Alert: No)

Tyler Durden's picture




 

Submitted by Omid Malekan via OmidMalekan.com,

Stock buybacks have been in the news lately, as their growing size has lead to criticism, especially from politicians who believe they contribute to economic inequality. But the simplest critique of the practice of buybacks can be made on economic grounds, in terms of value created or destroyed.

If you ask a seasoned investor to boil success down to one sentence, they’ll probably say “buy low and sell high.” Ask them to simplify even more, and they’ll say “buy value” – which usually correlates with buying something when its cheap. If we flip these maxims around then the worst kind of investing is to buy high. Expensive things do occasionally become more expensive –  but with greater risk.

I have always been weary of buybacks, going all the way back to the last buyback boom before the financial crisis. My concern then was that by purchasing shares management was making a declaration, that this is a good time to buy our stock, as opposed to the past or the future. But if management knows that then it knows how to time the market, and if management knows how to time the market, then it’s better off running a hedge fund. Since management is instead running a company, it should focus on what it was hired to do and leave the stock market alone.

Taking the practice to a more extreme measure, many large companies today are tapping the debt markets, borrowing money at record low rates and using the proceeds for buybacks. The practice is popular among blue chip companies like Apple and Microsoft, who despite their cash heavy balance sheets prefer the tax efficiency of financing buybacks with debt. The old me would find such a practice even more unwise, as it entails timing two markets at once, a feat even a seasoned hedge fund manager would have trouble pulling off. But the old me didn’t understand how buybacks really work.

To call an action market timing is to imply participants care about price. They are buying today because today offers a good price whereas tomorrow might not. But executives doing buybacks don’t care about price. We know this because new buybacks are not announced with any limitations on share price. We are going to buy back $2 Billion worth of shares in the next quarter. What happens if share prices rises drastically beforehand? Management doesn’t care.

We also know this because currently, with the stock market at all time highs, new buyback announcements have gone parabolic to amounts never seen before. The current level of buying recently surpassed that of 2007, at the previous peak of the market.

 

But the buying has not been continuous, as companies took an extended break during the financial crisis while stock prices fell drastically. If you chart buybacks versus the overall stock market in the past 10 years you’ll find a neat correlation.

For over a decade now corporate management has been doing the exact opposite of what constitutes good investing. If you include the fact that some of the companies buying back shares before the crisis were selling shares to raise capital during the crisis, and are now buyers again, then management has been buying high to sell low to buy high again.

If you acted similarly in any other walk of life you would be the subject of ridicule and featured in finance books on what not to do. Imagine walking into a dealership and saying “I am going to buy this car, regardless of what price you quote me.” Then imagine selling that car at half the price, only to eventually buy it back at a premium.

On Wall Street however such behavior is now the norm. Take the example of Royal Dutch Shell, which recently announced the acquisition of BG Group. The deal is mostly financed by Shell issuing new shares. It’s said to be accretive next year, as in increasing the company’s earnings and presumably its stock value. It also comes with a plan by Shell to buy back millions of its own shares in 2 years. So the company has promised to sell something today, drive up its value tomorrow and then buy it back next week.

All of this would be laughable if not for the consequences. The net amount of buybacks executed in recent years has now surpassed $2 trillion. That’s $2 trillion in capital spent on an activity that at best creates no value and historically has destroyed it. As our business leaders continue to speculate on why the current recovery refuses to kick into high gear, they should look at wasteful buybacks as one possible impediment.

 

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Fri, 07/03/2015 - 14:44 | 6266667 Publicus
Publicus's picture

It's simple, a company with $1 million in cash and 1 million share at $1 each buys them all back and cancels them. What do you left with? 0 dollar and 0 share.

 

Stock buyback destroys value.

Fri, 07/03/2015 - 17:43 | 6267124 magnetosphere
magnetosphere's picture

bull shit.  it abolishes the public stock market, which is exactly where we need to go to realize a steady state economy.  no more exponential boom and bust

Fri, 07/03/2015 - 18:36 | 6267273 Thomas
Thomas's picture

Leveraged share buybacks are tantamount to selling your company to your creditors.

Fri, 07/03/2015 - 15:19 | 6266740 SillyWabbits
SillyWabbits's picture

It’s worse than that:

A company with no income can pay executives millions of dollars without it impacting the bottom line.  Or any line on the balance sheet.

Hence, management becomes funds managers and never needs to build anything.  Once it is realized that the company is only in business to issue stock, the price falls; but management gets to keep the money collected from outside the company product lines.

Fri, 07/03/2015 - 15:22 | 6266741 MollyHacker
MollyHacker's picture

It's a simple math equation when the currency resets the stock valuation will reset with relatively short lag time. It's a safer move buying back as a hedge against lost revenue, then selling long, later when needed.

Fri, 07/03/2015 - 15:42 | 6266794 power_shift
power_shift's picture

Buybacks increase the price of a share but destroy the value of a company. Capital that should of been spent in R&D, equipment, expansion, etc. is instead spent reducing the amount of shares on the open market thus increasing the price. Price does not equal value though as many of us have seen in a large number of companies on Wall Street that actually produce nothing.

Fri, 07/03/2015 - 15:49 | 6266806 cigarEngineer
cigarEngineer's picture

Stock buybacks do not inherently influence value in either way. Your alternative of R&D and capital expenditures ignores the return on invested capital that could be realized by shareholders if they took their profits and invested in other companies with a higher return on invested capital or higher growth. If a company holds cash hostage or invests it in low-return activities (compared with other things it's doing) it deprives investors from choosing how to allocate that capital more efficiently.

Fri, 07/03/2015 - 15:46 | 6266802 cigarEngineer
cigarEngineer's picture

Stock buybacks do not influence value. Value drivers are return on invested capital and growth (growth is a value driver only as long as the ROIC is higher than the weighed-average cost of capital). Stock buybacks are the best way to return cash to shareholders, as dividends force income and the associated taxation onto everyone, while stock buybacks allow each investor to decide when to sell and cash in and get taxed. 

Besides, what do you guys care about a corporation? It's designed to be looted. it doesn't deserve cash. The weaker large corporations get, the better for smaller upstarts to obliterate them in the market.

Fri, 07/03/2015 - 16:10 | 6266885 Palladin
Palladin's picture

Well it depends on who you ask. These officers and directors of MCP would tell you share buy back's are a good thing. For them anyway. But at the end of the day it didn't turn out too well for regular shareholders.

Insider                                                            Purchase                Sale
ASHBURN JOHN - Officer                           163,300          4,827,804
BALL RUSSELL DAVID - Director                    50,000                   -  
BHAPPU ROSS - Director                       25,000,000        694,213,833
BURBA JOHN - Officer                                     -              6,034,857
COGUT CRAIG                                                 -          618,730,260
DOLAN BRIAN - Director                             249,136        694,213,833
DOOLAN MICHAEL - Officer                         250,000               -  
HENRY CHARLES - Director                        3,170,002         3,519,000
KARAYANNOPOULOS CONSTANTINE - Director  100,000            -  
KRISTOFF MARK - Director                                 -          240,689,588
MOLIBDENOS Y METALES S.A.                    45,000,000      -  
RESOURCE CAPITAL FUND IV LP                          -          694,213,833
SMITH MARK - Officer Total                       1,011,634        13,137,915
THOMPSON JACK - Director                                   -          3,213,123
TNA MOLY GROUP LLC                                       -          116,951,400
Grand Total                                                74,994,072     3,089,745,446

Fri, 07/03/2015 - 16:15 | 6266903 SweetDoug
SweetDoug's picture

'

'

'Wait until I buy those shares from them at 20% of the price of today, in a bit!

 

•?•
V-V

Fri, 07/03/2015 - 18:05 | 6267189 besnook
besnook's picture

buybacks are just another, albeit, legal form of skimming profits for personal enrichment.

Fri, 07/03/2015 - 20:10 | 6267568 lester1
lester1's picture

So what happens if Janet Yellen raises interest rates on all this buyback debt?

Mon, 07/06/2015 - 00:55 | 6275181 onmail
onmail's picture

Share buyback creates a hurricane.

1.Pro-capitalist govt gives free QE money to banksters & corporates
2.They use it for share buyback
3.Share prices go higher

4.Pro-capitalist govt gives free QE money to banksters & corporates
5.They use it for share buyback
6.Share prices go higher

& so on

Till share prices reach very high
So high that the only way is --

DOWN
--------------

Thats what a hurricane does - destruction

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