IBM (NYSE:IBM) has been widely criticized for what investors call financial engineering. One of the key poster children for share repurchases, the legendary company disappointed Wall Street with its most recent quarterly results. The general take was that IBM's long-running practice of shrinking its outstanding share base through aggressive stock buybacks no longer would be enough to support its EPS (earnings per share), let alone please investors; this is no more than financial engineering.
Critics may take it a bit too far, yet I also do not believe that aggressive stock buybacks are always good, and I do agree that they are sometimes (though definitely not always) used as financial engineering. It is a fact that cutting the count of shares outstanding, through spreading any given level of earnings over a smaller number of shares, has the effect of boosting EPS, everything else being equal. Thus, the practice can theoretically be abused by management being particularly aggressive during a quarter of poor financial performance in order to show better EPS trends than otherwise would be the case.
But definitely not all share repurchases are created equal. The practice as a consistent way to distribute part of the total remuneration to shareholders can be quite favorable for investors over the long haul. I appreciate stocks with attractive shareholder yields, particularly when managements do not find better uses for excess cash. It is very important that the actual number of shares outstanding does consistently drop when a company has a practice of aggressive stock buybacks.
Many companies use stock as a significant component of their executive compensation. If a corporation uses large dilutive issues of stock to compensate its management and employees, it must also buy back a significant amount of shares in the market just to keep its total share count from increasing. Thus, it is important to see a trend of decreasing shares outstanding before even thinking of rewarding a company for repurchasing its stock.
It is also key, in my view, that a company uses only excess cash generation to repurchase stock in the long haul. Increasingly, corporations are issuing debt to finance large share buybacks. I would be wary of any meaningful increase in net debt that is used for stock repurchases, as such practice may indeed be approaching mere financial engineering.
At the opposite end of the spectrum, there are companies with significant share count increases. Stock sales are also of many different types. Something that really annoys me from US financial news media reports is the widespread confusion between secondary and follow-on share offerings. Even initial public offerings [IPOs] can be both primary and secondary. The distinction between primary or secondary share sales refers to whether the offering results in an expansion of the share count (primary - the new funds go to the company) or not (secondary - existing shareholders in the aggregate sell some of their stock, so no new funds go to the company itself).
Thus, even share sales in the private market (before the IPO) can be primary or secondary. In conclusion, the term secondary does not refer to an offering not being an initial sale, as the financial media here often implies. The correct term for public share sales after the IPO is follow-on offerings, and again, follow-on offerings can be primary, secondary or a combination of the two, depending on the entity or entities actually selling the shares.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.