najdorf

Where Have All the Buybacks Gone?

There's really no reason to conflate the issues of excessive stock option issuance and stock buybacks (football frank, others). Let's imagine what would happen to a company that issued a ton of options, paid big dividends, and didn't buy back any shares. For a while this company would look great to the high-yield crowd. Then they'd hit a point where all the issuance diluted the free cash flow to the point where it was difficult to continue to pay the dividend and continue to invest in the business. Because most people never learn from the past, they'd keep paying the dividend, a few smart investors would head for the exits, and the share price would start to erode. Then the high-yield crowd would back up the truck for the even higher yield. Eventually you hit a crisis where they really can't pay the dividend any more, cut it radically, and watch the share price crash. All without the dreaded buybacks...

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.

4 Unbelievable Stock Charts: Freeport-McMoran, Alcoa, Peabody and Goldman Sachs

You might be right about FCX having a comeback, but you're wrong that commodity prices don't matter. The company is completely levered to commodity prices. What is their book value constituted of? Inventory, property, plant & equipment, and goodwill (not much cash on hand). The inventory consists of commodities and commodity-derived products. The properties, plant and equipment are valuable for no reason other than that they produce commodities (remote Indonesia? desert in the American SW? Congo?). The goodwill is from acquisitions of other companies equally levered to commodity prices - what's this worth if they have to shut down the mines they acquired?

Come on. If your only business is selling copper, gold, moly, etc. and the price of those items declines, your earnings will decline. If they decline far enough you'll go bankrupt. What kind of liquidation of FCX's assets could you run in this climate? You really want to bet that there's anything left over for equity-holders if we don't see a commodity comeback? The only thing keeping FCX afloat is that they come across some gold while mining minimally profitable copper.