Sajal

Why You Should Short Companies Doing Share Buybacks

I like the comments. Taking the opposite side of a well accepted notion does upset quite a few people!

Firstly, the opinions expressed by me are also shared by the McKinsey Quarterly article and the Audit Integrity report I linked to above. So clearly, I'm not in a minority here.

hhcramer: value is a matter of perspective. We've had periods in the world where markets went nowhere for 30-40 years, and stocks ended up trading at 2-3 times earnings multiple.
Buffett has a margin of safety to fall back on in case he is wrong. Even Buffett, despite the margin, has commited mistakes with his initial investment thesis. He has been right, on average.
The problem is you cannot really forecast industry trends, substitutes, competitors, pricing power, markets, economy too much into the future. A lot of times, companies don't have an intrinsic valuation to backup their claims.

Budh: Even though you are cynical, you are mostly right.

Theguy: I like LLTC, I do think using debt to buyback their stock was a smart strategy.
The analog sector is a great example to illustrate share buybacks. ADI MXIM LLTC TXN have all bought back stock, sometimes even buying back 40% of their float. This has been going
on for a few years now. Look at where the stocks have gone over the last 5-6 years.
Maybe Mr. Market is delivering a verdict on the undervaluation thesis here? If no one recognizes the undervaluation argument, and the stocks remain where they were for the past 5-6 years, maybe we need to revisit the argument? I intend to blog about financial engineering in mature tech sectors like analog in the future. I'll elaborate on a few of my thoughts there.

DSX Lover: Here's an example of how a buyback can be dilutive to earnings. Let's ignore effect of taxes for now. Say a $1 billion market cap company has 100 million in cash.
Interest rates are 5%. It's net income was 40 million, including 5 million in interest income.
Let's say the EPS is 2 and it had a 25 P/E multiple, giving it a stock price of 50.

The company completed a stock buyback with it's $100 million in cash, buying back 2 million in shares. The number of shares went down from 20 to 18 million. The new net income would be 35 million, giving it an EPS of 1.94. So the EPS just went DOWN from 2 to 1.94 after a buyback.

Result : dilution.

Hope this helps.