Sajal

Why You Should Short Companies Doing Share Buybacks

Thanks for the insightful comments everyone. I'm trying my best to keep up :)

BillyRayValentine: I agree with you.

If you were to include taxes, then you should compare after tax interest rate with earnings yield.

I agree that using a 20% tax rate in my example would imply breakeven in EPS. But if you were to bump up the P/E to 30 or increase the interest rates to 6%: you'd still get an EPS dilution.
The idea was to illustrate that dilution CAN occur.

MC: Valuations are a matter of perception. With cyclical stocks, the least you should do is use normalized 5-10 year earnings and then compute the earnings yield. Cyclical stocks always look the cheapest at the peak of the economic cycle because of earnings which have been inflated due to the business cycle. Using a 10% earnings yield based on the trailing 12 month PE may not be a valid exercise IMO.

To take your suggestion a step further, every company then should employ a trading division to trade their stock in the market!

When Buffet invested in Korea, stocks there were trading at an everage of 2 PE. In Japan right now, I believe the average stock is trading below book value. In 1982, with the market trading at low single digit PEs, you had several stocks trading at low single digit PEs.

Stonebluff: do you have a link to the S&P study?

drposhmoney: Two things:
1. You are assuming the company has the pricing power to pass on any inflationary increases. A lot of companies can't do that.
2. If you are adjusting the cash for inflation, you should also be adjusting the earnings for the same. A $1 in earnings today versus $1 in earnings in 2015 have different buying power implications.

We are talking in nominal terms here. Inflation adjustments to all the numbers should cause no difference to the buyback argument.