Where Have All the Buybacks Gone? 35 comments
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A stock represents an ownership stake in a business. But why should that stake ever be worth anything? In the worst cases, imprudent management funnels future earnings back into unprofitable endeavors and overpriced acquisitions, and your stake could become worthless. In the best cases, prudent management deploys capital where it can provide productive returns—either by growing the business organically, making acquisitions, paying dividends, or repurchasing its outstanding stock.
In recessionary periods, attempts to grow a business organically often do not meet with immediate success. However, if a recession depresses the market value of your business, buying back temporarily cheap shares becomes an interesting—albeit fleeting—opportunity.
The sharp market declines in the fourth quarter of 2008 created one such opportunity. Yet, as a S&P report recently revealed, members of its S&P 500 spent $48.1 billion in stock repurchases in the fourth quarter, a 66% decline from the $141.7 billion spent during the fourth quarter of 2007. This, despite the fact that cash levels stand at record highs.
So why the pause? Howard Silverblatt, Senior Index Analyst at Standard and Poor’s, attributes the cash conservation to uncertainty about future cash flows. And for a company like Alcoa (AA), such uncertainty seems warranted, for the company recently came to the market with an equity offering at $5.25 per share. This, after spending 2007 buying back the same shares near $40.
These billion dollar mistakes should not be taken lightly. Of course, saying it sounds obvious, but little outrage seems present within Alcoa’s shareholder ranks. If such mistakes are repeated consistently enough, the shareholder will find herself left with a piece of paper destined for the toilet.
And so today’s recessionary times illustrate what may be the most important component of a business’ economic moat—rational capital management. When management directs capital to its most productive endeavors, one finds stagnant textile mills blossoming into global insurance empires. Yet, for most business managers, this discipline seems so rare that a Randian would be tempted to call it heroic; even wide moat businesses like Moody’s (MCO), with its long history of stock buybacks, seem to lose their best habits in uncertain times.
If only a select few can manage capital well in uncertain times, the investor must use these times to scout for demonstrations of rational management. As the S&P report shows, Exxon (XOM) led the way in the fourth quarter, followed by Microsoft (MSFT) and Oracle (ORCL); included also are such stalwarts as General Mills (GIS), Johnson & Johnson (JNJ), Procter & Gamble (PG), Philip Morris International (PM), and Pepsico (PEP).
To become a stock owner of a great business does not guarantee investing success; nor does buying a great business at a bargain price. No, investing success requires owning great businesses purchased at good prices whose capital consistently finds its highest and best use, especially in times of economic uncertainty.
Disclosure: No Positions
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This article has 35 comments:
Not Rocket Science is it?
Not Rocket Science is it?
moneyneversleepsblog.b...
Mr. Wrixon is not exactly correct. A MSFT or CSCO does have a huge cash hoard and CAN buy back in the face of two or three years of poor cash flow. And while their share prices are depressed, the prices are not as depressed as some others because of those cash hoards.
There are two reasons to prefer buybacks over dividends; tax efficiency and flexibility. The first is a serious problem only because the US has almost the highest corp. tax rate, and a medium high dividend tax rate. It is the investor that pays the corp. taxes and so dividend taxes are an unavoidable double tax. The investor can choose when to take capital gains and so manage his/her tax hit.
Maybe one day our gov. will stop punishing dividend investors, and corp. management will see the light, but I won't hold my breath.
I vividly remember reading an SA article written by a management consultant about why the flexibility of buybacks are the only way to go, because it makes life easier for managers. Yes, it makes it easy for them to manage our capital badly!
In general, dividends reflect a commitment by management to take care of its owners, buybacks usually represent an attempt by management to appear to do good, while shoveling money into their own pockets.
Reality is that most companies are struggling to borrow, when they can despite zero nominal interest rates it doesn't exactly come cheap. And few of them are making a profit at all, let alone one big enough to justify buying back their own stock.
In good times this kind of action would have increased share values. Don't you think they would be doing it now if they could do the same? The truth is this kind of action would gravely undermine the balance sheets of most companies, which could potentially result in disaster.
And well if Moody's are making money after their ratings performance last year, then it just goes to show how fixed Wall Street actually is.
On Apr 11 01:32 AM ozcutty wrote:
> moodys bought back a fair bit of stock last year, but most of it
> was with borrowed money. That poses another question doesn't it,
> are companies right to borrow to buy back? If your business is growing
> at 10% and you can borrow at 5% is it good practice to lever up to
> buy back?
Thanks for highlighting the oddity companies often only buy back shares when they are high because there are so few drivers to add appreciation to their stock at such heights.
PEP beats KO in my mind due to the fantastic snack foods division. General Mills is the archetype recession stock, as is PM. ORCL, is, well, ORCL.
The dunce cap goes to Dow component AA, buying at 40 and selling at 5. Cyclical companies should plan for the lean times by provisioning cash better.
Corrective action would be for boards, when authorizing buybacks, to state strict and rational economic criteria for the prices to be paid. A conservative multiple of EBITDA (4X?) comes to mind, or maybe tangible book, as minimum criteria.
(number of shares outstanding before buyback) / (number of shares outstanding after buyback)
Without this necessary adjustment, buybacks disproportionately benefit management's options at shareholders expense. This leads them to buy back their stock, no matter how high the price, just to make sure their most recent and expensive options can be liquidated at a profit.
On Apr 10 12:44 PM stonebluff wrote:
> Has anyone tackled a study of the damage done by buybacks to American
> financial corporations? I cannot understand the rationale for buybacks
> except when the assets underlying the shares plainly exceed in value
> the price of the shares. Then, and only then, do the shrareholders
> as a group benefit. Buybacks otherwise benefit only EX shareholders,
> who sell into the buyback storm. With buybacks, management is making
> an investment decision with regard to my money; I would prefer to
> invest it myself. Give me cash dividends. I'll invest them where
> I choose. Buybacks carry even a mild odor of corruption, since managers
> with options are commonly large and regular vendors of their companies'
> shares, and buybacks tend to mask the dilution caused by prodigal
> use of options.,
> jack
In order to manage capital well in uncertain times you have to manage capital well in the good times. As we see, there are very few that actually did so. Those that leveraged up to do buy backs in the past few years will be suffering the consequences for a long time.
Sounds like Home Depot to me !!
management and the board get, it really cancels out the benefit of
buy backs. Dividends that are re-invested at a lower price give
me a better return in the long run
Doug T.....The mutual fund guy
www.mutualfundwealth.com/
To answer your question, in the extreme worst case scenario, and also in my humble opinion, one could look to CHTR and IDARQ.PK as potential examples.
Both companies finally succumbed to Bankruptcies filings. In other words, they had to resort to that ultimate solution knowing that:
1) They do not have the financial means to buy back anything (drown in debt already);
2) Shareholders value has literally gone to ZERO - no need to buy back anything.
A shudder runs through my spine as this Rude Awakening is indeed true.
Teutonic
On Apr 10 12:11 PM Mad Hedge Fund Trader wrote:
> I was wondering the same thing.I have a question, Mr. Market. If
> General Electric (seekingalpha.com/symbo...) got down to
> $5, Bank of America (seekingalpha.com/symbo...) to $2, and
> Citigroup (seekingalpha.com/symbol/c) to $1, where were the
> share buybacks? Are these companies too broke to buy their own shares,
> or do they think a few bucks over zero is too much to pay? I’m not
> sure I like either answer, or even my own question.
>
You should only hate options if your management is moronic and corrupt, and you shouldn't invest in companies for which you believe the management to be moronic and corrupt. Paying a great manager in long-term, slow-vesting options at the current market price with a holding requirement is just like paying him in cash, except you motivate him or her even more to make the company perform. If your manager isn't worth it, advocate your point of view to your board. If your board is cutting corrupt deals or looking the other way while management cashs out millions in options while running the business into the ground, fire them. If you can't make action happen, sell the stock to a greater fool and look for a decent investment instead.
The problem is not the buybacks; it's the dilution from overcompensation of poor executives. Buybacks are fantastic if the purpose is to increase the amount of FCF available to continuing shareholders, which can support either further profitable business expansion for a more concentrated group or greater dividends. However, in order for the buyback to work the shares of the company have to be cheaper than those of other companies and cheaper than the immediate direct capital investment options.
For instance, imagine a great business that trades for 5x FCF - unless you can find an expansion plan that yields greater than 20% immediate safe returns, why wouldn't you buy back some shares with the available cash? Why would you pay a dividend to shareholders so they have to pay tax and then go through the hassle of finding a new investment or paying a commission on more shares of something they already own?
Now, there may not be many companies that actually fit the criteria for buybacks - many of the best companies are regularly over-priced in the market and would do better with internal expansion or dividends to income-oriented shareholders. But there's no sound reason to philosophically object to buybacks of all kinds.
Divide the cash figure by the current liab figure. This represents that cash flow available ( not including additional financing) to fund the operations for the current period. If the result is less than 1, then the company doesn't GENERATE enough cash to operate, and must rely on other sources to meet its most basic requirements to operate. Thi s is a simple measure of the company's "cash".
Buying back a company's stock and even giving a dividend is a drain on resources that can have consequences- and the reason that buybacks at even low stock prices are being cut as well as dividends.
Many companies are want to even predict results given the uncertainty of declining results, acting to reduce cash resources is usually risky in these times. A better avenue to raise stock price is often the reverse split- a different prospect for another time.
Cash IS King
Until such time that it happens, no real recovery will be insight.
Ironically, the sooner we reach that stage, the better off will be for the economy at large.
Unfortunately, the government is still self-hypnotized to indulge in intervention to prolong that eventual climax - a sad and even tragic story.
This makes me think of an analogy - the squirrels in my backyard, also during Q4 of 08, were burying their nuts in preparation for the winter. It seems a lot of companies (both fat and thin) were/are burying their cash in anticipation of a long cold economic winter.
My first thought was that the large drop in buybacks might be sector specific (financials, consumer discretionary) but as the data shows, it's across the board. Sure some sectors display larger drops (Telecom, Cons Disc, Financials, Utilities - this last one surprises me) but even the "small" drops for Industrials and Materials is still of the order of 50%.
So what triggered the start of the buyback boom in '04 anyway?
Avoid them at all cost.
On Apr 10 02:59 PM Blake Winston wrote:
> Anybody catch Sheldon Adelson, Chairman/CEO of Las Vegas Sands buy
> 7.8 million shares of his own stock two weeks ago? It's not exactly
> the same thing; however, in theory I supose it should insipre confidence
> in the entity as a going concern is the head hancho is buying that
> much stock.
On Apr 11 11:16 AM Teutonic Knight wrote:
> Mad Hedge Fund Trader,
>
> To answer your question, in the extreme worst case scenario, and
> also in my humble opinion, one could look to CHTR and IDARQ.PK as
> potential examples.
>
> Both companies finally succumbed to Bankruptcies filings. In other
> words, they had to resort to that ultimate solution knowing that:
>
>
> 1) They do not have the financial means to buy back anything (drown
> in debt already);
>
> 2) Shareholders value has literally gone to ZERO - no need to buy
> back anything.
>
> A shudder runs through my spine as this Rude Awakening is indeed
> true.
>
> Teutonic
>
> On Apr 10 12:11 PM Mad Hedge Fund Trader wrote:
On Apr 10 12:44 PM stonebluff wrote:
> Has anyone tackled a study of the damage done by buybacks to American
> financial corporations? I cannot understand the rationale for buybacks
> except when the assets underlying the shares plainly exceed in value
> the price of the shares. Then, and only then, do the shrareholders
> as a group benefit. Buybacks otherwise benefit only EX shareholders,
> who sell into the buyback storm. With buybacks, management is making
> an investment decision with regard to my money; I would prefer to
> invest it myself. Give me cash dividends. I'll invest them where
> I choose. Buybacks carry even a mild odor of corruption, since managers
> with options are commonly large and regular vendors of their companies'
> shares, and buybacks tend to mask the dilution caused by prodigal
> use of options.,
There is an assessment of the impact of stock buybacks on US equity markets on Capital Market Watch that suggests that the total amount of buybacks since 1983, when the SEC essentially gave "safe harbor" for this type of manipulation, with Rule 10b-18.
Based on Federal Reserve data and other sources, the article shows how buybacks financing went well beyond current income, dipping in depreciation reserves and bank credit.
In terms of 2008 dollars, the total impact of the "buyback era" is estimated at $5.7 trillion. The 2008 crash has removed an essential source of funding for buybacks, perhaps for a long time.
See capital-flow-analysis....