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Companies with low growth have a few options (assuming strong cash flow).

1. Distribute cash back to shareholders via buybacks or dividends

2. Increase R&D spending on new initiatives

3. Acquisitions

Buybacks are at least much more tax effective than issuing dividends. Large acquisitions tend to fail and I imagine it could be hard for an established company to regain the "growth mindset" of a startup.

Should a company load up on debt or pursue buybacks way above intrinsic value? Probably not. But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).

> But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).

It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over.

That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature.

At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits.

This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.

Why does a company have to grow, if it's doing what it does well, workers are happy, and customers are happy, and growth is not occurring naturally?

Could it be that the expectation for all companies, everywhere to grow at a constant rate is not reasonable?

Well, if you have that attitude, you won't be CEO for long. Shareholders want return, and get to replace the CEO. So for public companies this doesn't work.

I get your rationale, but you have to remember that this hypothetical company would probably generate a fair amount of cash. The question then becomes, what do they do with that cash? Say a company has a steady state $10B revenue, $2B profit and requires $1B of reinvestment capital with a market cap of $20B. After 5 years, the market cap becomes $25B all things being equal due to an additional $5B of cash on the books. Eventually, the company's value would start to be primarily cash. In a low interest rate environment, it could be hard for this company to make money on this cash, and investors are probably more interested in the company executing its mainlines of business versus turning into a hedge fund to manage of huge cash position. A stock buyback is one way this company could "grow" in revenue and earnings per share, but not have to try and grow top line revenue.

I guess I don't understand the mindset in which having extra cash is some sort of problem to solve. Apple, Microsoft, Cisco, Oracle, Qualcomm, etc. all have large stockpiles of cash and no one thinks of them as hedge funds, right?

Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly.

Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.

Yes, though most of the purchase is usually paid in stock.

They didn't just write a check for $19B.

Usually true, but they want the optionality of being able to purchase in cash if the buyer demands it. DoubleClick ($3.1B) and Motorola ($12.5B) were both purchased for cash. Not many buyers have $12B in cash sitting around.

Apple actually does have a quasi hedge fund to manage its cash position:

https://qz.com/393093/the-mysterious-fund-in-the-desert-that...

Too much cash can also lead to behavioral finance issues down the road as well such as companies making ill-fated acquisitions such as Microsoft did under Ballmer's helm.

Excuse me if this sounds tongue-in-cheek, but is "behavioral finance issues" another way to say that the people placed in charge of the large pile of cash can't be trusted with it? Are you saying the solution to that is to just not to hold any cash?

That fund does not remotely resemble a hedge fund. They strictly invest in low-risk securities (e.g. highly rated government bonds) to generate a modest return and minimize loss against inflation.

Why not give the cash to the owners. That's what stocks are for, right. Doesn't seem like a problem at all. A "low growth" company is a stable company. High growth is high risk.

That's essentially what a stock buyback does. The two options to return earnings to the owners are to issue a dividend, which is taxed at a higher rate or to buy back stock which drives up the value of outstanding shares thus returning value to the shareholders

I've read this explanation (two equivalent choices, one is taxed higher than the other) so many times, but I can't believe there's no downside to stock buybacks. Something about it just feels very wasteful, like picking the fruits of a tree just to grind them into compost for the soil under the same tree.

>like picking the fruits of a tree just to grind them into compost for the soil under the same tree

The difference being that your example would at least enrich the soil and potentially improve future yields (like R&D), while buybacks are essentially just propping up the stock price with no fundamental contribution to future success.

Buybacks only return money to shareholders who choose to sell. Instead of distributing the company’s profits proportionally to its owners, it becomes a game of chicken as each investor has to decide when they should get out.

Well the population of the U.S. is still increasing at about 2% per year, and the global population faster than that, so a company staying the same size is actually shrinking as a proportion of its market.

>"Buybacks are at least much more tax effective than issuing dividends."

Why are buybacks much more tax effective? Is this due to the way the accounting is done on them?

Assuming an investor owns the stock in a taxable account, dividends are taxed at ordinary income whereas if the stock appreciates due to stock buybacks, it could be taxable as a long-term gain (if held for more than a year).

https://mebfaber.com/2016/05/02/much-dividends-costing/

>>> In a taxable account dividends could have cost you anywhere from 0.3% to over 3.0% in returns PER YEAR since 1974.

Interesting I always think of the "income vs capital gains" as a consideration for individual tax payers. I didn't realize it also pertained to corporate purchases of their own stock.

It does pertain to individual tax payers. Tax payers can either pay ordinary income on dividends or capital gains tax on the sale of share with increased value.

Even better is that as long as the shareholder holds, they have increased value, but can defer taxes.

Simplifying things quite a lot, say that you have a share in a stable company priced at $1000. During the year the company makes $50 per share in profits and the price gradually goes up to $1050. The company can pay a dividend: you get $50 and pay taxes on them (and your share is now worth $1000). The company could also use the money to buy its own shares: you still have a share worth $1050 and no tax is due (yet).

> Companies with low growth have a few options

This is true. It is always better to return money to shareholders if there aren't any avenues of future growth.

But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.

As others have pointed out, it is important to evaluate these actions on a company by company basis. On the other hand, if you invest in index funds, then the proportion of who is doing them and why matters a lot.

The worst case scenario is a company with declining market share, that is cash flow negative, and is buying back shares with debt because the executives set their bonuses based on an earnings per share target.

I strongly suggest novice investors is to look at shares outstanding for a company over time. Just as one could claim share buybacks mask a companies problems, you can make a case that issuing new shares steals money from existing shareholders. Indeed, there are public companies which have been around 10+ years and stay afloat solely by creating new shares and have generated 0 return for long term shareholders.

Which is part of why stock buybacks (of one format) have some major upsides: if/when the company decides it wants/needs capital, it can sell shares from its own holdings, and not be issuing new shares

I think you are operating from a seriously mistaken assumption of how stock buybacks work.

When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits.

Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.

All this requires no ongoing buybacks from the company. You do it once, and because the denominator shrinks, each stock appraises. After that, as long as profits remain stable, earnings per share will, and so should, absent external factors, the stock price.

The kicker is that these buybacks were financed with debt,

None of what you said conflicts with my understanding of how stock buybacks work. I never said it was an ongoing activity, just criticizing companies who do stock buybacks to artificially inflate their share price in a down market. My argument has nothing to do with profits or dividends or ownership, just share price.

>a company buys their own stock... [and] each stock appraises

That lines up exactly with what I've described. If you're saying I'm wrong, you're going to have to be more specific because I don't see where we disagree.

>just criticizing companies who do stock buybacks to artificially inflate their share price in a down market. My argument has nothing to do with profits or dividends or ownership, just share price.

There is nothing inherently wrong with performing stock buybacks, from a cashflow perspective it is equivalent of paying a dividend, in fact it can be prudent from a tax perspective. You did imply that it is a continuous process when you suggested:

> when the money runs out, the buybacks stop

Performing a stock buyback based off the proceeds of debt in a down market makes perfect sense actually because you can significantly reduce your cost of capital if you believe your future cashflow will be strong enough to continue making coupon payments. You can issue debt at say 3.5% and buy out shares that require 7% cost of capital and as long as interest rate and credit risk don't drastically deteriorate significantly increase the value of your company from a simple capital markets operation.

If that's what people understood as implied, it was not what I meant to imply and I apologize. What I meant by that was, you can only buy back stocks up until the point where you run out of money. Not that you HAVE to, but if your goal is to manipulate your share price, you can only do it up to the point where you're out of money. If I'm spending money from my savings account, there is no law saying I have to spend all the money in my savings account, just a law saying I can only spent up to the balance in my savings account.

I guess you assumed I was arguing that companies who do buybacks must dump all of their money into buybacks, which I certainly did not mean to imply. Big difference between "able to" and "must".

The point is, if you as a company are trying to manipulate your share price in a down market by buying back stocks and you choose to continue buying your stock until the market rises again, you're taking the risk that you will run out of money before the stock market rises again. At that point your share prices fall no matter what.

> I guess you assumed I was arguing that companies who do buybacks must dump all of their money

No, wrong again. People take issue with your representation of stock buybacks as "short-term market manipulation". The major effect of buybacks comes not (just) from the increase in demand, but from lowering the denominator future profits are divided by. It directly increases earnings per share.

Okay I am done with this thread and everyone (what I can only assume is intentionally) putting words in my mouth that I never said, while ignoring words that I did say.

I never said companies must spend all their money on stock buybacks, yet that argument is being used to paint me like an idiot.

I never said every company who does buybacks is doing it to manipulate the market, yet that argument is being used to paint me like an idiot.

I never said anything about dividends or profits or ownership, in fact I literally said I'm just criticizing companies who do buybacks in order to increase their share price during a down market, yet the argument that "not everyone who does buybacks is manipulating the market" keeps getting thrown at me like that thought has never crossed my mind. I know you think I'm an idiot but I did say words that have meaning and I used those words intentionally to convey the exact meaning that society has agreed those words are supposed to mean. It is not my fault you intentionally choose to ignore those words and their meaning.

I've had enough of it. Either read my words then comment or don't comment at all. I'm sick of this, defending my comments against people who only have bad faith and want to pretend that they're smarter than me because they purposefully misread my comments.

Your entire argument is based on an intentional misreading of words I never said and in direct response to the comment where I argued against that intentional misinterpretation and I'm not engaging with this any more.

When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits.

Technically true, but the company had a choice about how to return profits to investors and chose the buyback over the dividend, so the remaining owners don't get a larger percentage of profits unless the company also issues a dividend. It's generally an either-or these days.

Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.

Not all McD's stock is publicly traded. Moreover, a fair amount of McD's stock cannot be legally sold due to it being owned by ESOPs. That being said, the remaining stock owner would not own 100% of McDs, they would own 1 share of McDs (and 100% of then-outstanding stock). There would still be several million shares authorized and in reserve that could be sold or re-issued at a moment's notice. The decision to sell/re-issue those shares is made by the company, not the owner, and the fact that he theoretically owns 100% of the company at that time is meaningless because he owns only a fractional percent of the company's authorized shares and thus has no actual power.

I’ve always been curious about this.

Who, if anyone, owns the shares that are held in reserve?

Surely they can’t be used to vote, unless they are held as an asset by the company in the same way the company might hold shares in other companies as assets.

Do they exist on the balance sheet?

Nobody owns the shares in reserve and while in reserve they have no voting or dividend rights.

While in reserve, they are neither assets or liabilities or really even anything other than a hypothetical number. Many companies used to disclose the number of shares in reserve, so that shareholders were aware of the potential dilution of their investment, but in an era of buybacks, that has become less popular.

@freehunter Yes, you were and are quite right. We´re looking at a feedback loop not entirely dissimilar to the one that caused the '29 crash. Only then it was corporates lending to banks to lend to investors to buy shares. I guess this one is a little more direct.