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Comment by nabla9 | Hacker News Reader

> drowning out real investment.

The conclusion that buybacks are alternative for real investments is wrong.

The aggregate change between R&D and capex versus buybacks and dividends is not just some arbitrary decision. ROI from R&D and investments is slowing down for various reasons.

Instead of investing more without reason to do so, companies should give profits to owners or pay off excess debt.

There is wrong and right way to use buybacks. When company is not overvalued relative to its earnings, buyback is viable alternative for dividends. Taking debt to do buybacks or pay dividends is insane.

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Companies (often ones with business both in and outside the US) generally borrow money to pay for buybacks (Apple as an example). So corporate debt goes up, paid out of future earnings if they exist, to keep the stock price up and keep shareholders happy. But it is not making business value which ultimately is what business exists for and should reflect in the stock price. So the price is propped up for some time period based on distant profits that may never happen, instead of reflecting company value improvements in the more near future.

Apple is probably a bad example, here. It's got more cash than it knows what to do with-- nearly as much cash as debt. And its debt is at a relatively low interest rate. It's arguable that while interest rates are so low, it makes sense to take on a bit more debt than usual, and when interest rates get high, it makes sense to reduce your debt ratios.

Apple is really bad example.

Apple did buyback for a right reason. They are drowning in cash. Their debt is not an issue at all.

I've never understood this take. Buybacks cannot be analogous to dividends because they require you to relinquish your stake in the company to realize the gains.

It's a public buyout offer, not profit sharing.

That's only true if you own single shares that you can't divide. If the market cap of the company is divided in enough shares that everyone can sell their portion of the buyback then it can be exactly like the dividend. And investors often directly reinvest the dividends so if you are holding an index fund that reinvests dividends, buybacks or dividends are the same except for any tax differences. If you're holding an index fund you also don't have the problem of the shares not being divisible, because someone else is managing that in aggregate for you.

They are analogous to dividends.

Example: You own 10% of company with market cap $100M. You have $10M.

Dividend scenario: company pays 3% dividend, you get $300k. You have $10M + $300k = $10.3 million.

Buyback scenario: company buys it's own stock for the same amount. You own 10.3% of the company. You have $10.3 million. If you want, you can sell stock to get $300k in cash.

The only difference is that in the buyback scenario you can decide when to sell (and pay taxes).

Slight nit: The math you're using is creating money from nothing. You started off with $10M and by dark magic you now have $10.3M.

What really happens is that you start off with $10M in stock.

With dividends you get $300K in cash, but now the company doesn't have that cash anymore so its value is reduced by $300K, so you end up with $300K in cash and stock which is now only worth $9.7M.

With buybacks you sell $300K worth of stock to the company. Then you have $300K in cash and the $9.7M in shares you didn't sell which are still worth the same amount because even though the company has less cash it also has fewer outstanding shares and those cancel out.

This is ignoring the effect on valuation of separating the business from the cash -- if the business is more productive than the cash then that may indeed make the share price increase, because then you have a more concentrated investment in the more productive business instead of having the investment diluted by being forced to also invest in an ordinary pile of cash that happens to be part of the same corporation.

> The math you're using is creating money from nothing. You started off with $10M and by dark magic you now have $10.3M.

I think the idea was that the company is worth $100mn at the beginning and it accumulates $3mn of cash over the year that it wants to distribute somehow to remain a $100mn company.

>> and the $9.7M in shares you didn't sell which are still worth the same amount

"Worth the same amount" as what value? 10 million? If so, then doesn't that also create 10.3M in value (ie created 300k from nothing)?

Mmm, that perspective doesn't really reflect the, I guess, party liquidity in a practical scenario.

The company has money, they trade at $X. In a trivial sense it means you can buy a share for $X +- some spread.

The capital return mechanism is that the company now owns the share, and can retire it, the part that really isn't important is who they got it from.

It's sort of like electrons in a metal, they're just sort of around. Worrying about the behavior in specific instances doesn't paint the picture of the aggregate behavior.

That’s a difference, but they are still analogous. Not realizing the gain is actually a helpful tax avoidance strategy. I’m investing long term, I’d rather not realize the gain.

+1 million

OK. You're probably right. I still hate it. There's not a viable explanation that doesn't make it seem shortsighted and greedy (personally, and possibly due to HN filter).

Why is R&D not a good investment suddenly? Shortage of tech workers (blah blah) ...?

There are a lot of different reasons.

The cynical take is that the time to ROI is too long. If it is going to take 10 years to turn a profit the executives do not want to pull the trigger on that because they will be out the door in 5 and never get the payments.

Another possibility is that all the low hanging fruit is gone. So the marginal improvements do not return large financial gains.

Sadly both of the reasons you listed ring true.

you’re on a board very nearly dedicated to startups.

perhaps the s&p500 is no longer a good place to do r&d, compared to smaller, vc-backed startups. if they see significantly reduced gains from r&d compared to smaller companies then we should be crying years of joy that money is flowing out of them so it can be reinvested into smaller firms.

It is still a good investment, but the timelines are getting longer as the challenges get larger. This is happening simultaneously during a time when attention spans and patience are decreasing.

I suspect regulatory capture is part of the equation too. It's overall cheaper to effectively ban competition than to actually compete.

For the same reason acquisition are getting more common innovating in a large corporate environment is very hard.

Toxic individualism. Me above all. Consequences are for chumps. And it's all so cynical. We see this in politics as well. One last dash pillaging the world for money and power, burning it down to the ground in the process.

It is drowning out real investment, this conclusion is correct because the companies themselves are saying so in their statements. Some companies are taking on huge debt to keep up in the buyback races despite having bad products that are losing market share. Oracle is probably the biggest example of this buyback insanity via debt, but there are many other companies doing the same thing.

https://www.cnbc.com/2019/12/05/oracle-shows-buybacks-can-go...

Other companies have committed in their financial statements to "returning 100% of free cash flow to investors via buybacks and dividends", so they are actually committing to not invest in the company at all regardless of how much money they make. Chevron and Texas Instruments are two big examples of this, there are dozens of other companies with similar buyback first strategies.

That's very interesting because that is what you would do if you wanted to liquidate a company and shut it down (on a leisurely timescale). Exactly how much of the US economy is being wound down? Maybe this is a great opportunity for new businesses with an appetite for R&D risk, maybe this is the US laying down so that China will replace it faster.

Absolutely. What we are witnessing is people extracting as much money as possible from healthy and unhealthy companies just because they can. This has been going on in the private equity/hedge fund world for decades, buybacks are the mechanism that is now being used on the public markets in similar, unethical ways.

Oracle is betting on not having a future, they are extracting as much money as possible from the vehicle before it goes off a cliff.

Based on what I know about Oracle's software quality to customer inertia ratio, they're probably betting right. I wonder if the future is as legitimately bleak for all of the other buyback companies.

Take a look at balance sheets. Price to Book ratio has been growing on major company names. Book value is the equity remaining after assets - liabilities. Assets are dwindling/remaining constant and liabilities are growing due to debt funded buybacks. There will be no equity left many big names in the public markets due to the debt load.

It’s all a big wealth transfer game. The entire world is along for the ride hooked on index funds owning enormous stakes in these large companies and will be left with the bag in any downturn. No downturn can ever happen now and everyone knows it, especially the Fed. The current system can never correct otherwise it would implode. CEOs are exploiting this fact to full potential and will be gone/dead before any consequences arise.

Corporate debt-to-GDP has never been higher

I'm aware.

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