First Step to Fix the Markets: Let Shareholders Vote on Buybacks

I have written an article in the past about my negative thoughts on share buybacks. In my opinion, they are a horrible waste of capital.

If I were Obama, the first step I would take to fix the markets is the following:

Allow shareholder votes such that if a board of directors determines that there is excess capital that can be used for share repurchases, that the shareholders (via a vote) could instead opt to receive the cash as a payout (dividend).

Under this scenario, there would be an either/or scenario – the cash pool would entirely be spent on a share buyback OR a dividend, depending on the shareholder majority vote. I would also be tempted to disallow mutual funds from voting, but that may be a subject for a different article.

What would this accomplish? First, I believe that shareholders DO NOT feel like owners of the companies they invest their money in. But they should. They are the owners! If I ran my own business, you would be crazy to think that I would allow someone else to tell me what I could do with excess profits that weren’t reinvested in the business. By allowing a shareholder vote, owners (shareholders) of the companies would determine where excess profits were sent, NOT some incompetent board of directors. To be honest, I can’t even contemplate an argument against my proposal.

A second benefit to such a shareholder vote is that it may force boards of directors to do away with obscene stock and stock option awards. My theory on this is that if shareholders were smart and wouldn’t allow these terrible share buybacks, boards of directors would be less willing to dilute the number of shares (via stock compensation) since there would be no opportunity to buy shares back to offset the dilution. The real effects of excess and obscene compensation would be more recognizable.

I would bet that after this recent run of corporate management malfeasance, shareholders would almost always opt to take cash right away rather than let the board of directors throw it away. If this is too strong a statement, explain why Goldman Sachs (run by the smartest guys in the business) buys back stock at much higher prices than when it issued shares to raise capital. There are many examples of companies doing this. The only argument against taking cash versus doing a share buyback is the tax hit of 15% on dividends.

My second recommendation to Obama would be to LOWER the dividend tax (a zero percent rate would make the most sense), making the share buyback less of an attractive option.

It is my opinion that implementing these rather simple measures would greatly restore credibility in the stock market. Allow the owners more power, pure and simple.

Comments

[icandoitdon:]

i never buy companies that squander capital by buying back their own shares. it shrinks the capital base and leverages the business. those who do so are not fit to run companies. those who believe this is a good way to "return" money to shareholders are simply ignorant.

Jan 01 01:32 PM

[Tom Armistead:]

Dan, you have correctly identified a problem that has been going on for years. But there are two sides to the issue.

I have owned companies whose management has greatly increased shareholder value by buying shares at discount prices, specifically Tessco (TESS).

I can't remember the name but there was one company where the board establisehd value-based criteria to determine when buybacks were in the best interest of shareholders. The requirement of such criteria would improve corporate governance.

As a thought, many companies are now trading under tangible book value per share: if the cash is available buybacks make a lot of sense under those conditions. Examples would be MBI and HTCH.

So from my perspective a good solution would be to require boards to establish definite value-based criteria to support any buyback authorization.

Jan 01 05:54 PM

[icandoitdon:]

i would be willing to bet that for every company that you can find that has "wisely" repurchased shares i could find 5 that did so unwisely. there are two reasons why capital should never....NEVER...be squandered in this fashion:

1. equity capital...as many ignorant managements and boards are now learning...is a precious and scarce resource. it is the most expensive form of capital and it is not always available when you need it.

2. management's job is to produce a product or service in a competitive environment. it is not financial engineering. companies who rely on such cheap tactics to raise EPS or boost the stock price too often get what they deserve....higher financial leverage, lower operating leverage and a stock price that goes nowhere. i can cite countless examples of this in recent years...target stores, microsoft, GE, macy's....all of these companies have spent major dollars on share buybacks. many have sucked air for years...and some have engineered themselves into a less competitive financial position.

as for boards of directors establishing value-based criteria to support buybacks...puhleeze. reread points 1 and 2. that's all they need to know.





On Jan 01 05:54 PM Tom Armistead wrote:

> Dan, you have correctly identified a problem that has been going
> on for years. But there are two sides to the issue.
>
> I have owned companies whose management has greatly increased shareholder
> value by buying shares at discount prices, specifically Tessco (TESS).
>
>
> I can't remember the name but there was one company where the board
> establisehd value-based criteria to determine when buybacks were
> in the best interest of shareholders. The requirement of such criteria
> would improve corporate governance.
>
> As a thought, many companies are now trading under tangible book
> value per share: if the cash is available buybacks make a lot of
> sense under those conditions. Examples would be MBI and HTCH. <br/>
>
> So from my perspective a good solution would be to require boards
> to establish definite value-based criteria to support any buyback
> authorization.

Jan 01 07:23 PM

[icandoitdon:]

by the way....

i looked at a chart of TESS.....

at the end of september 1994 the share price stood at $11.33 adjusted for a 3:2 split in nov 06. it reached a high of 31.38 in February 07. it's current price is $8.71. it has never paid a dime in dividends.

during the 14 year period, the stock had one two year period where it tripled in value before collapsing in price. if you made money that's great. but the stock buyback had utterly nothing to do with it.

thanks for providing just one more example of ignorant managements squandering precious capital because they think they have an undervalued stock.

Jan 01 07:42 PM

[Tom Armistead:]

I agree on Macy's - I had a small position which became a very small position. After they got the waiver on their covenants and the stock rallied for a minute I took what was left of my money and went on to other ideas, primarily out of disgust at the 3 billion I think it was somebody said they spent buying back shares and now they need the money badly.

TESS I owned in 2006 and got out in early 2007 a very happy memory, During that time they used their line of credit and bought back a block of shares at prices well less than what I sold out for.

The situation as it stands today is if a company needs equity capital they can't get it because they will be shorted mercilessly while trying to raise the money and nobody in their right mind will put their money in front of that process. Financial companies in particular almost need a separate warchest so they can defend themselves when attacked.

Allstate is another company that has a history of buying back their shares that I think adds to their value.

You are correct that buybacks are more often a waste of money than not, I still think therer are exceptions to the rule.




On Jan 01 07:42 PM icandoitdon wrote:

> by the way....
>
> i looked at a chart of TESS.....
>
> at the end of september 1994 the share price stood at $11.33 adjusted
> for a 3:2 split in nov 06. it reached a high of 31.38 in February
> 07. it's current price is $8.71. it has never paid a dime in dividends.
>
>
> during the 14 year period, the stock had one two year period where
> it tripled in value before collapsing in price. if you made money
> that's great. but the stock buyback had utterly nothing to do with
> it.
>
> thanks for providing just one more example of ignorant managements
> squandering precious capital because they think they have an undervalued
> stock.
>

Jan 01 08:22 PM

[Sepod:]

AAPL is a textbook case wherein Management can spend $5BB - $10BB buying their shares back without even breaking a sweat. They've been sitting on a rapidly growing stockpile of cash that, as of now has reached $25BB. And the only thing this cash horde gets them is a fabulous balance sheet, besides that, it merely sits there and grows. Yes, they've purchased a few Companies here and there, but that hasn't even dented their pile in the least. The stock is down from 203 approximately a year ago to a current price of 85. What better way to open up the purse strings than to buy their own shares at prices that may never be seen again. C'mon Steve Jobs let's see a share buyback, as that may very well be the impetus that AAPL needs to give it a kick start in the butt, so this wonderful stock can have a price equal to it's greatness. BTW Steve, while you're buying back AAPL shares, how about if you get on the Toob and tell your adoring public that not only are you still alive...but flourishing, as that would add additional credence for a precipitous rise in AAPL shares posthaste.

Jan 01 08:58 PM

[icandoitdon:]

there are always exceptions to the rule. my objection to stock buybacks is the mindless mantra dutifully repeated by financial journalists, analysts and other members of the financial ignorantsia that stock buybacks are good for shareholders. it's utter rubbish.

as for apple.....

you are probably young so i forgive your naievete. about 10-12 years ago apple was in financial distress, partly because of their failed strategy of not making their products windows compatible. they were losing market share badly to IBM and IBM compatible products and had also lost a series of patent infringement lawsuits against MSFT regarding their graphical user interface. they were on the ropes financially. to rescue themselves apple finally had to make their machines windows compatible and, in a settlement with microsoft related to other pending litigation, obtained from microsoft $150 million of desperately needed capital in exchange for non voting stock. the hated microsoft saved their bacon when they could have helped bury them. but that kind of publicity they didn't need, long having been a target of antitrust regulators. apple went on to bigger and better things only because they were forced to open their sytem up.

my point is this:

even the smartest CEOs can make mistakes and fortunes of even the most successful companies can change. capital should always be regarded as a precious resource and should not be squandered away on some lame-thinking CEO ego tripping over his "undervalued" shares. it's not his job to judge whether his company's shares are undervalued...it's the market's job.

as for steve jobs, beware investing in any organization that has a cult following, as does apple computer. if you're fortunate enough to get in early it works. if you get in late it doesn't. also beware of mythical CEOs, of whom steve jobs is one. jack welch was one, too, and revisionist historians now regard him as much a cook as a CEO. he did a great job cooking the books at GE when cooking the books was viewed with a wink and a nod. carley fiorna at HP was another smoothe talker with a lame background. she came from a tired, old monopoly business called western electric, which became lucent technologies. remember them? HP finally woke up to her fraud and gave her the well earned boot. i don't, by the way, put jobs on their level...he's better than them. but he's just a talented CEO supported by a lot of people just as smart or smarter than he who are part and parcel to apple's success. he's not a miracle worker.

if a company wants to return value to shareowners let them pay dividends. buybacks are for idiots who don't understand corporate finance.





On Jan 01 08:58 PM sepod wrote:

> AAPL is a textbook case wherein Management can spend $5BB - $10BB
> buying their shares back without even breaking a sweat. They've been
> sitting on a rapidly growing stockpile of cash that, as of now has
> reached $25BB. And the only thing this cash horde gets them is a
> fabulous balance sheet, besides that, it merely sits there and grows.
> Yes, they've purchased a few Companies here and there, but that hasn't
> even dented their pile in the least. The stock is down from 203 approximately
> a year ago to a current price of 85. What better way to open up the
> purse strings than to buy their own shares at prices that may never
> be seen again. C'mon Steve Jobs let's see a share buyback, as that
> may very well be the impetus that AAPL needs to give it a kick start
> in the butt, so this wonderful stock can have a price equal to it's
> greatness. BTW Steve, while you're buying back AAPL shares, how about
> if you get on the Toob and tell your adoring public that not only
> are you still alive...but flourishing, as that would add additional
> credence for a precipitous rise in AAPL shares posthaste.

Jan 03 12:30 AM