Stock buybacks are dangerous for the economy
feeds.hbr.org
feeds.hbr.org
This seems to be the crux of the article, and it appears to be completely unsubstantiated.
First of all, this article isn't about just stock buybacks -- the argument of the article applies broadly to dividends just as much, save for minor details.
The point the article is making is that profits ought to be reinvested rather than paid out. But obviously mature firms often can't find ways to reliably re-invest. They don't need to grow any further, nor should they. So investors want them not to re-invest, and throw off dividends or buybacks instead. This way investors can fund the next generation of companies.
And taking on debt to do it isn't inherently irresponsible. In fact, it's just a wise financial decision when interest rates are low. New revenue streams aren't required to be generated -- it's just shifting a subset of future revenue to the present.
So I really don't get this article at all.
With this kind of mindset, I'm about to say fuck it, let's not bail these companies out. Let's let capitalism take its natural course.
Weak companies (such as the airlines during the COVID-19 outbreak) need to be allowed to die. If we rescue these poorly managed companies, they will continue to be poorly managed and will need to be rescued again. If they die, they will be replaced by new, better managed companies who won't make the same mistake (because nobody will want to own their stock otherwise).
This virus will likely turn out to be a 2-3 quarter demand shock, something that any well-managed company should be prepared to survive.
Is there much evidence to support this?
I'm not saying I've studied the data, but just thinking about what has happened over time it seems reasonable to suspect there are companies that have gone bust, only to be replaced by new companies that then also go bust. This is true of natural selection too: it doesn't necessarily produce organisms that are immune to unexpected shocks.
Edit: I also want to add: if the airline hadn't done the share buy back, wouldn't it still be suffering from the unexpected economic shock?
So yeah, a "stronger" company will emerge from the ashes. But only because other people took a bath.
It's like if the bank forecloses on your house. You owe $200k, but they sell it at auction for $50k. The above argument is like saying the new owners who bought your house will be a much stronger financial situation. This is true, but it ignores the fact that majority of involved parties are worse off (you & the bank).
Say you're a business that has razor thing margins but huge turnover, like airlines for example.
Do you need to save for 14 rainy days, or 1400? When your war chest is exhausted do you then go looking for bailouts?
I suppose one answer is to allow government bureaucrats and industry interests to nut out some regulations, but that's different to what you're suggesting.
The reason people are angry is because individual citizens are left to figure it out on their own when a downturn happens, but corporation's are allowed to be flagrantly irresponsible and then still get massive subsidies or bailouts when in trouble.
For everyone here coming up with excuses about how this is a good thing to bailout these companies, please answer me this.
Why do the leaders of companies in a recession always end up with more money from bonuses funded by the government bailouts, while individuals have to tighten their belts?
The average person doesn't believe your arguments when it boils down to "heads I win, tails you lose" everytime we have economic turmoil as a result of greedy actions by corporations
Will it also be accompanied by a sudden and unexpected shock like a global pandemic?
I agree with your point about executives being paid too much while the company and staff suffer, but that's a separate issue.
My point I was trying to make is that we are treating individuals with the cold hard truth of full boned capitalism, but when it comes to corporations we suddenly have all these excuses and help for them.
If we are fully capitalist then the only answer to the right sized war chest is one large enough for the next recession. Whether or not its difficult or impossible to determine what that size is, if you don't have one big enough your company will go into bankruptcy.
If that sounds like a ridiculous burden to put onto companies, _then why do we put it onto individual citizens?_
Yep, generally agree.
A strong social safety net seems important to me. Here in Australia we do have social security and a healthcare benefits program. So there's that.
its not like someone can just do an airline startup and flights are mandatory for a modern economy.
we're in a big ol' interconnected world, where the way things are going a fairly large sector (tourism/travel/food industry is a little less than 15% of GDP [or was 2017]) is likely going to get decimated. 1 in 100 of those firms will not be able to survive for 3 months the way things are going, much less 9. that's no fault of their own, it's just that most businesses can't be expected to plan for disaster-level events within their wheelhouse - a great many have trouble hitting payroll every 2 weeks.
Btw this sort of state-run "capitalism" isn't really socialism either, to me it is more reminescent of the 1930s in Southern Europe.
https://en.wikipedia.org/wiki/Troubled_Asset_Relief_Program#...
Airlines spending every spare penny they had, and in some cases taking out debt, to gamble on the market and keeping nothing in the bank as a safety net is one such side-effect.
On my next tshirt
For the record, I would bail these fuckers out, but it would come with some hefty costs. Loans at 12%, reserve requirements, no ability to carry forward losses, more leg room, emissions requirements, and no more share buy backs. You want to return money to investors, you do it through dividends.
Leveraged stock buybacks are essentially a bet that the company will fail as it maximizes investor ROI to fail with as much debt as possible. That destabilizes the economy and should be flat out illegal due to moral hazard.
It’s really simple. If companies can’t issue buybacks or dividends with outstanding debt or unfounded pension liabilities society is simply better off. Compromising to say cash on hand + 1/2 the value of physical property > debt is probably fine. Notice how neither of them would change the theoretical stock price of a company and thus invested returns, yet it’s a significant difference in reality.
This is just the sort of fun financial engineering challenge that will not end the way the rulemaker intended...
Dividends are direct payments to investors who will presumably stay investors — the buy back is a ‘buy out’ of existing shareholders.
There are quite a few more reasons a buy back is different from a dividend - but probably the most interesting bit is this: for a massive company with limited places to compound their retained earnings, by buying back stock the company pays all the dividends it would pay in perpetuity immediately in that instant. This is all fine and sometimes prudent in a net present value equation.... as long as the cash flows remain consistent*
*which is now the issue at hand with Covid-19
I don't think that's true at all. Every day there's massive liquidity -- buying and selling -- of any publicly traded stock.
Buybacks are generally implemented gradually over time, to the best of my knowledge, and are simply buying the shares people are selling daily regardless, the existing liquidity.
Obviously because there's slightly more demand, the price creeps slightly higher, and a margin of people decide to sell (e.g. for $201) where they wouldn't have sold slightly lower (e.g. for $199). But obviously those people were generally looking to sell in the first place.
So the idea that buybacks somehow discourage or reduce investing or discourage long-term investment seems totally mistaken.
If this is a truly capitalistic society - what should really happen is that all the bought back stock needs to be reissued (sold back) into the market — but that would create excess supply, reduce price, then freak out everyone’s 401k.
Finance is a crazy web and really cool - but massively complex. So you are right that there is liquidity every day, but that liquidity does not affect the total number of publicly traded shares until the purchaser is the corporation itself (the buy back).
The real screwed up compounding variable in liquidity is who is actually buying (awesome when it’s actual primary investment aka private fundings and ipos, and messy when it’s the secondary market aka the ticker price) — guess what’s even more messy: Passive Funds like ETFs. Passives (where 401ks live) are now the primary vehicle of investment for average America so really no individual investor is actually buying an individual stock- instead you buy a ‘share’ in a prorated basket of stocks based on ratios set in investor agreements (vanguard ishares etc).
When money goes into the ETF, the fund buys 10% x, 10% y... so on of the basket of stocks they market. No earnings have changed, no cash flows, but external secondary market forces now drive the market.
This is what Michael Barry (of the Big Short) is waiting for next - along with Water, which will be the next decades issue.
But your main point in this comment seems to be:
> If this is a truly capitalistic society - what should really happen is that all the bought back stock needs to be reissued (sold back) into the market...
But why should stock buybacks have to result in shares later being reissued, and what on earth does that have to do with "true capitalism"?
None of that makes any sense at all. The entire point of a buyback is to raise the stock price, as an alternative to issuing dividends. Saying that stock needs to be reissued later is like saying all dividends ought to be paid back by investors in the future. It doesn't make sense, indeed defeats the entire point.
This may be what people say now adays (the price going up is the reason for buy backs), but when I went to school and worked on a Convertible Notes desk, the stock price going up is not the reason to issue buy backs - it’s usually because you think your price is so cheap and you can reduce your cost of capital by removing the stock from circulation. The nouveau riche way of doing things is — well we can give you 100% of the cash back now, instead of paying a 5% dividend for x years (x because of compounding / whatever else is your assumption).
[Edit: now that I said this, it sounds a lot like packaging up seemingly derisked assets and marking them as safe (aka CDOs from The Great Financial Crisis (GFC)]
The ETFs are important to understand the full landscape of liquidity - but yes, point taken.
So to your question — in a pure free market, a corporation would tap the shareholder base (like Warren Buffetts cash, like he did in 08) rather than a TARP like agreement. The reason we did TARP was because the engine was seized up (Banks had effectively no funds to lend because a few lost all their assets) — right now it doesn’t look like the engine is seized up (no big hedge funds or banks have blown up [yet I guess]). So really, the company should issue new initial stock back to a Buffet or someone similar at a discount. But the discount is what would make everyone’s portfolio look awful.
So because the government shut everything down - we say... well we made you shut down, so we will take the hit here.
But really the nuance is that, had these airlines not financed buy backs with cheap debt, they could have weathered this storms themselves. These airlines were making so much money they were never thought to be able to lose money again! Matt Levine just put out a great piece on it [0]
So in the free market (and consequence lens), these buy backs financed with debt was a bad business decision - so the natural consequence is to just unwind the transaction, sell back into the market for 80Bn, and restart. Prices would take a serious, serious hit, but the new direct investors would be rewarded with a recovered share price. They would literally be buying the dip.
And just for added info, investors are bailing in these airline stocks because if the gov’t comes in like last time, the shareholders were wiped out first, then the company is allowed to recover. (Fannie and Freddie are still not private... the day that happens, will be a $100Bn transfer from the gov’t to the people)
[0] https://www.bloomberg.com/opinion/articles/2020-03-17/the-go...
And people wonder why anti-'intellectualism' is on the rise. When you see this sort of stuff happening over and over and over again, you start to think that maybe believing people or giving their ideas more credit because of the letters after their name might not be a great idea.
I think its sad, the legitimacy the sciences brought to education and its institutions is being eroded and abused by non-science folks who dress up all their BS in scientism and use that legitimacy to push it onto others.
But the way the cash is transferred matters, and it has second order effects. Specifically, as it impacts stock options.
Executives tend to be compensated with options. The more the stock goes up, the richer they get. Distributing $X in dividends should provide an equal total return to the average shareholder as spending $X on a buyback, but that buyback will do it by pushing up the share price.
As the share price goes up more and more, execs with options have disproportionately more to gain than the average shareholder. They have a leveraged exposure to the price!
Then any regulations should focus on them.
Why should I, as a 'retail investor', be punished for return on capital methods because of the chicanery of executives?
I'm just going to DRIP any dividends anyway (until retirement) since I don't need income now. I want buybacks because that way I do not have a tax event that has (tax) drag on returns.
Edit: sorry about that, I get it now after thinking through it more.
Let's say the stock is truly worth $100 (assuming we could figure that out). Then if the company does buybacks, the stock trades at $100 - great for the executive with stock options. However, if the company pays dividends, then the stock price is reduced by the expected value of those dividends. So total expected value is the same, and long term executive comp is the same because they get the dividends as well, but short term they would prefer the buyback because of the higher stock price. They only benefit the same from dividends if they have a long term view.
If I pay a $1 ps dividend, then the share price should halve, and the share owners get $1 each.
If I buy back 50 shares, at $2 each, there will be 50 shares left at a value of $2 each. But now my earnings/share goes up as if by magic, and my options are worth more than in the dividend case.
Also capgains vs income tax yada yada
That's not correct. The EPS increase is offset by reduction in company value due to less cash. https://business.financialpost.com/opinion/stock-buybacks-ar...
The options bit is a slight fiddle, although empirical evidence supports it.
Some executives are compensated with RSU's. Some with options. If you're negotiating compensation and it's options, you'll take into account whether the company does buybacks or dividends when comparing offers.
In the end the total package is the total package. So I just don't see anything "wrong" here.
1. Steadily pay out dividends or buy-back stock based on profits. Buy-backs benefit those who hold onto an unwinding venture longest, whereas dividends provide an even return. Eventually when the company has nothing left to sell the business shuts down.
2. monetize the companies balance sheet and distribute money to the investors - Mortgage the assets and borrow against future earnings. The goal in this approach is to steadily transition from low-risk to high-risk debt and eventually bankrupt the company. Naively one would expect such an approach to yield ~5x the value of an otherwise mature business, and leave creditors on the hook.
The latter approach needn't be malicious either, simply leveraging a mature business until it can only support interest payments would be viable - bankruptcy would occur when the company runs into trouble and has no assets to invest.
The latter path needs to be regulated to have a healthy and stress resistant economy.
Not if interest rates are low.
Suppose interest is 1% and a company takes out a 5-year loan. They pay ~$1.05 to distribute $1 per share now instead of waiting 5 years to distribute it.
I, as an investor, can take that distributed $1 and reinvest it at, say, an expected rate of return of 5% -- so that in 5 years I'll have ~$1.28.
Obviously that's a much better total deal in the end. I, as an investor, want the company to take on reasonable low-interest debt for dividends or buybacks. Which is exactly why companies are doing this.
This is the middle ground between your options #1 and #2, which is financially wise for companies who expect to continue to have healthy profits. Which is exactly why companies are doing it.
This is where I get confused. Say APPL was $100 share, and so many people buy it that it goes up to $200/share. How does this really benefit APPL? They don't ever issue more shares from what I can tell (they don't need to raise capital).
Why does the share price of APPL/AMZN/TSLA matter to them? To attract investors/keep a board of directors happy, sure
But what do they financially gain by their market cap going up?
I don't know how someone could possibly make this statement RIGHT NOW of all times? How many businesses are sitting on the edge of folding right now? Whoops! Looks like all that future revenue didn't show up! Guess who's going to suffer for these decisions? Not the investors, they sold out! How about all the employees who just had all the blood sucked out of their job security and future livelihood?
In what sense are investors in this scenario not just hostile parasites? At least if it were dividends then the investors would have any sort of remaining long-term interest in the success of the company, and not just how they can most quickly disentangle themselves from taking any responsibility for the survival of the company that they ostensibly had ownership over by gulping down revenue it didn't even generate yet? In what sense is the investor not crippling the company and leaving it weaker than they found it? It's vampirism! Just because the money is there for the taking doesn't mean you should, it doesn't mean that what you're doing isn't irresponsible and even morally reprehensible.
You create a nightmarescape of shambling zombie companies just waiting for a global pandemic to remind them that they're all already dead. Enjoy your artificially juiced stock value after it craters because our entire economy is short of legs to stand on.
It's far more reasonable to do business as usual and then take loans if things go south.
As Matt Levine put it: the dividends they gave since the GFC come to $15 billion, and their equity comes to $12 billion. So it's not even given it would have been the appropriate thing.
> How about all the employees who just had all the blood sucked out of their job security and future livelihood?
Right. It's like banks. How do we handle it?
Insurance: if you want to be a FDIC-insured bank, you must pay the FDIC insurance, and in return they will backstop your creditors up to a certain limit if they go bankrupt.
Why couldn't we do the same for employees? If you're an employer of systemic importance, you must have employee bankruptcy insurance: if you go tits-up, your employees get their salary paid up to a maximum limit of $X/yr until they find a new job. The insurance premiums are set by the free market, purely capitalist.
This is the most shocking hubris I've witnessed in a long time.
How can a business take out loans when things go south if it already leveraged itself in good times? Why would new investors buy into a company saddled with debt used to pay the old investors?
Dividends pull the share price down, and allow the recipient to choose whether to reinvest or take cash.
If the goal were simply to return capital or concentrate ownership, dividends would be more than sufficient.
Buybacks have a different goal. Their goal is to inflate the stock, provide liquidity on selloff days, and take cash off the firm's balance sheet in a way that improves metrics used in fundamental analysis that compare the company's value to its earnings.
Some companies compensate executives based on share price appreciation. In that environment, a share repurchase has tangible benefits for the executives who choose to do it.
A lot of these monkeyshines were stopped by the recent tax reform, which brought US corporate tax rates down to levels comparable with most of Europe.
It's the same reason both consumer and government debt are also high. But anybody who thinks now is the time for higher interest rates is a bit confused.
If anything now is the time to print a bunch of new money to counteract the existing deflationary forces caused by the coronavirus, which in the long term is what allows interest rates to rise, since once the deflationary forces wane the printed money would start to cause inflation which could be counteracted by at that point raising interest rates.
I'm curious as to whether the money would ever make it into the hands of the average consumer (which is where I'm assuming it needs to go to actually cause an increase in inflation, considering how consumption-heavy our GDP is, but correct me if I'm wrong!) There have been recent calls for the government to distribute money to prop up demand, but won't banks lobby politically against this sort of activity? Seems like a lender wouldn't want inflation to actually increase because that would cause their current lower-interest loans to be less valuable? One of the oft-cited concerns for continually missing our 2% symmetric inflation target is that market participants will begin to expect and plan for low inflation, which has a negative feedback effect on future inflation. Seems to me like financial institutions are already expecting low inflation and aren't all that interested in seeing it rise.
Low inflation kind of sucks for banks (and investors in general) because it tends to coincide with low interest rates. When interest rates are low, people borrow money and invest it, which reduces real returns by increasing competition to buy securities.
The people who dislike inflation (really, higher interest rates) are the people doing all the borrowing.
Care to cite a link for this? My understanding is that the money they loan you is physical and real, but the money “held” for savers is a fiction that could be lost if the bank went under, thus the reason that the federal government offers FDIC insurance for money deposited in banks, and why the feds are allowed to dictate interest rates and tell banks what overall percentage of their holdings they are allowed to loan out.
Banks (like everybody) use double entry accounting. When they make a loan, there are two entries. One is a credit to your account for the amount of the loan, the other is a debit representing the debt you now owe to the bank. You borrowed $5000, so you owe the bank $5000 (the loan) and they owe you $5000 (it's in your checking account), which cancel out. Notice that the amount of cash in their vault hasn't changed at all.
Banks have reserve ratios. They're required to keep a certain amount of their deposits on hand in case somebody actually wants to withdraw them. (Those just got set to zero, but they're normally something like 10%.) But as long as they've satisfied their reserve requirements, they create money from nothing when they make a loan.
When you pay back the loan, the debt of the loan and the credit in your deposit account cancel each other out again, they both disappear and the money that was created is destroyed along with your debt.
If you listen to white house press conferences, Sec Mnuchin said that he and the president of the united states would like to see direct cash payments to Americans in the next two weeks.
That's really good. The fed has been trying to spur inflation to hit their 3% inflation target for many many years now. However thanks to the great economy, we haven't seen that. Printing money would sure help create much needed inflation.
If the alternative is -10% GDP growth in Q2 2020 and God knows what later in the year, a little inflation won't kill banks
It doesn't have to be UBI either. The USA is desperately behind on infrastructure investment. In New York alone, we could use this opportunity to: build high-speed rail between NYC and Albany, rebuild the decaying Amtrak bridge in the Bronx, extend the NYC Subway with the Triboro Line, rebuild the Amtrak tunnels under the Hudson, heavily renovate NYCHA housing, invest in downtown beautification projects across the state, overhaul the Rochester bus system, etc etc.
What we need is a way for the Govt to get money into the hands of the people who will spend it on real stuff that will stimulate our factories and housing industry. Although helicopter money is a phrase I hear more frequently, the method of execution so that it doesnt appear as an entitlement is obscure. Personally, I think the Fed should print money with a half life. This 'Fed coin' should be issued to every taxpayer and the value of that bequest should gradually fade away until it is spent. At which point it enters the economy and it's value is fixed.
You don't even get the inflation until later, because all it's doing now is counteracting the deflation we would have otherwise. And later the inflation can be addressed by raising interest rates.
Crashing money velocity and vanishing credit. Inflation is a function of money supply and money velocity. Money supply is central bank money plus private money (e.g. checking account deposits) plus credit.
Demand destruction, like what we're seeing now, causes money velocity to plummet. That affects lending, which causes credit to plummet. (If we got into a credit crisis, it would cause private money to plummet.)
The increase in central bank money simply paled, even in 2008, compared to the destruction of credit and reduction of money velocity. As such, we actually experienced deflation while the central-bank money supply expanded. Because the total money supply, relative to the economy, contracted.
To get technical:
* https://en.wikipedia.org/wiki/Zero_lower_bound
* https://www.nytimes.com/2020/03/07/opinion/the-case-for-perm...
Hyperinflation is what happens when banana republics print their entire money supply a hundred times over every year.
How much inflation did we get from QE in 2008? In 2009 the rate of "inflation" was negative, and the Fed has been hitting the low side of their low inflation targets for more than a decade since, despite more rounds of QE and maintaining historically low interest rates. Meanwhile the entire world is hoarding US dollars (which causes deflation) because of this coronavirus.
The number of dollars we would have to print to unintentionally get hyperinflation right now is difficult to even imagine. We could print trillions of dollars and be lucky to get regular inflation.
It's time to let everyone reckless go bankrupt, and idiots who "could not see this coming" lose their money and jobs.
The business etc. will go bankrupt, restructured and purchased by people who know how to preserve the capital.
The reason why this keeps happening is because of moral hazard. We keep rescuing reckless behavior at all levels of society. Until there's no way to rescue anything, or the rescue package is going to kill the dollar due to its size.
Hopefully people have insurance to protect against some of this, but a restaurant owner that didn't plan for their community being shut down by a pandemic within a couple weeks of the first cases in town hitting the news wasn't being reckless
And yet, millions of Americans sacrificed, liquidated their businesses or shifted them to a war materiel production footing, changed jobs, bought war bonds, etc. Tens of thousands of diners and clothiers closed their doors in 1942, and Americans were largely happy to do it for the greater good.
This is precisely the opposite of what is occurring now - demands of bailouts, monetization, handouts, 50+ person St. Patrick's Day parties still going, bitching about having to learn how to cook, etc. A complete and total unwillingness to accept even a modicum of pain or sacrifice.
Businesses shifted to materiel production because they were told the have to, no?
So it seems fair that people are demanding leadership now too, no?
And America didn't even want to join until we were attacked first, even with the threat the nazis posed.
This was all happening in the middle of the new deal, one of the most significant, major government bailouts in all of american history, fundementally defining america as a welfare state.
And what do you call the huge amount of sacrifice by employers taking lowered productivity by sending workers to be remote? Companies that have declared they'll continue paying workers even if business gets shut down? What do you call the enormous social effort to get people to understand social distancing and flattening the curve? Did the populace even know what those terms were a couple weeks ago? What about the thousands of students packing up and going home, evacuating campus while their graduation ceremonies that they've been looking forward to for 4 years are cancelled? And do you seriously think that in all of america during world war two, nobody was a bad person that didn't accept pain or sacrifice, or even actively make things worse? What about jsut a few years before int he spanish flu when government stupidity led to the streets of philadelphia being filled with corpses because people didn't want to call off a parade? What about all the nazi sympathizers and eugenecists in the US that supported hitler? If your bar for "society is just and moral" is that literally no idiots hold a saint patricks day parade out of 360 million people, we've never been at that bar. The only constant through history has been people with superiority complexes on the side moralizing about how people used to be so much more moral (just like themselves of course) in the good old days, and how much society has decayed today.
In my very limited understanding the price of stocks were way to high already. The virus is just the proverbial drop, it is not the cause.
And demand shock isn't the extent of it. How many companies could reasonably have been expected to anticipate that their employees will have to work from home? Remote work isn't an option for everyone (good luck remoting into a wetlab), and some companies have built cultures that thrive on people coming into work to meet employees face to face, find opportunities for teamwork and innovation etc. This is a fundamental set of behavior changes, not just a simple demand shock.
Why "way too long"? Inflation was not a problem so why exactly did rates need to rise to cool things down?
The ECB did in fact raise rates at one point... and the EU recovery stalled. Krugman for one was very critical of raising them too soon, and he turned out to be correct.
Where does cash have to go? In Germany/Europe you have a culture of saving, so everyone stashes in "safe" accounts, and so government bond yields are at zero or even negative. Those folks would do better, both financially and for the health of the economy, to go with equities. German/EU governments would do well to spend more as well.
In the US people seem to be more culturally tuned to spending, and is "the" market to invest in world-wide, so a lot of folks are putting their money there. Potentially bidding up prices.
This is why Krugman is calling for a "permanent stimulus":
> OK, if you’re still with me: I hereby propose that the next U.S. president and Congress move to permanently spend an additional 2 percent of GDP on public investment, broadly defined (infrastructure, for sure, but also things like R&D and child development) — and not pay for it.
> The starting point for my argument is the astonishing drop in interest rates over the past few weeks. They were historically very low even a year ago, but at the time of writing the 10-year rate was only 0.76 percent. That’s below the rates on Japanese debt during the Lost Decade:
* https://www.nytimes.com/2020/03/07/opinion/the-case-for-perm...
Borrowing is cheap, so if the US is going to run deficits anyway, instead of 'tax cuts for the rich', there's a lot of infrastructure that's aging that could be rebuilt.
Savers deserve nothing special. Nobody is owed a safe investment vehicle with a positive return. If the market dictates that you have to pay people to take your money and hold it for you, then that's how it should work.
I mean, it's like if you have a bananna stand, and the gov prints billions of dollars to buy banannas on the open market, and now you have to sell your bananas for 5c a piece.
At full employment -- which we were at up until a week ago -- the only thing flooding the market with money can do is cause inflation. We didn't have an inflation, and interest rates were still incredibly low.
That's definitely one perspective.
How long can you sustain yourself after sudden and sustained loss of income?
One issue with a bunch of broke and homeless people is that a fair portion of them tend to be young males, who tend to have a bit of a penchant for violence.
How long do you think you can defend your hoard of cash and food against looters?
The economics are no different than a shop keeper getting a loan at .05% to pay himself.
the actual action in and of itself makes no sense from a business perspective.
The action basically is, a company doesn't have any good investments or R&D or whatever to invest in, so i'm going to return money to shareholders to do that
...but am going to take on debt to do that...because of dat phat interest rate doh??
Another important detail is that you only have so much stock you can issue. When you pay back a big wad of debt, you can take out some more debt. When you issue stock, that stock is basically gone unless you buy it back.
A share buyback results in an increase in share price because it reduces the number of shares of the company to buy. All things being equal.
McKinsey advertises as much
https://www.mckinsey.com/business-functions/strategy-and-cor...
The question is why would a company use debt to finance a buy back.
They use the loan to buy 10,000 shares at $100. The company does so anticipating the price of the shares will go up. Let's say the price is now $150. They sell the shares and get back $1.5m. They return the $1.02m owed for the loan and pocket the rest as profit.
If you believe the growth of your company's stock price will exceed the interest rate, you can make a profit using debt to finance a buy back.
This makes sense. Reduction in debt with the proceeds. Just like the other poster, you are concocting a strategy that is not happening. You hypothetical does not apply.
Instead, the companies are simply taking on debt and keeping it on their balance sheet.Now that there is a downturn, they cannot service the debt and need funding to operate (e.g. bailout) They are betting that the government will keep rates low or fund them in a time of crisis because they are too big, too important to fail. They've also bought up competition so they cannot just " go away" and let new entrants enter the market.
Yes, my example is an admitted oversimplification. I was directly answering the question "why would a company use debt to finance a buy back?", not "why would a company use debt to finance a buy back and then leave that debt on their balance sheet for an extended period of time?"
Although I suspect the answer to that question is that they didn't want to leave profit on the table and wanted to continue riding out the bull run, then got caught by the fastest bear market in history and weren't able to get out at a profit. Or that they believed they could eventually service the debt without having to reissue shares at all and ran out of time because of the crash.
For large cap companies that trade tens of millions of shares a day, you can figure out how much you can buy without moving the market. For less liquid stocks, you can also spread the buys out over a period of time to aim toward an average buy-in price.
The phenomenon you describe is called slippage [1], and those entering and exiting large positions are aware of it.
> it seems awkward to assume both that the volume purchased by the company significantly increases the price of the stock
I'm not implying that the reason why the stock price goes up is because the company is buying shares. The purchase may be done based on quarterly/yearly projections showing X% growth can be expected in the stock price in the future.
> the actual action in and of itself makes no sense from a business perspective.
At 0.05%, I'm pretty sure almost any business owner would take that loan, because if there's anything that can return more than 50 cents per year per thousand dollars invested in profit or avoided losses (e.g. solar panels or an ad campaign or a camera system to prevent shoplifting or whatever) that 0.05% loan is free money. I would happily take a loan at 10 times that interest rate for as much money as you wanted to loan me.
Making any of the reasons you stated above would make sense, but that did not happen
It’s not a business decision, it’s a financial decision. Why do companies go into debt at all instead of financing their operations with equity only?
Financing paying shareholders is the opposite of this.
But that's not true. The 43% number is just companies that capitalize R&D on the balance sheet. All companies must disclose buybacks, but only some capitalize R&D, (even though they all spend on R&D), so of course it skews the data.
That's just a poor comparison on HBRs part.
IFRS is a different beast but even then not every R&D can be capitalized
> Taking on debt to finance buybacks, however, is bad management, given that no revenue-generating investments are made that can allow the company to pay off the debt.
Not necessarily. Just as debt can be paid back by issuing more shares to raise capital, debt can be issued to raise money to buy back shares. It depends on whether management thinks the current valuation is too hot or too cold.
My fear is that these debt fueled buybacks actually create perverse incentives among options holders who have a lot to gain from short term gains in share prices.
Reckless increasing your leverage is a great way to destroy equity value due not only to increased interest expense but also from the cost of financial distress which investors price into their models.
Which is not to say companies don't do that – there's definitely a wedge between what's best for shareholders and what's best for management¹, but there's no way around it other than having shareholders run the company themselves (which comes with its own set of issues)
If you pay an exec team with fixed price stock options, they can run the company into the ground with debt to issue stock buybacks and do absolutely nothing to improve the business and increase the value of their stock.
Stock buybacks do have a place though. When you issue stocks, you're doing so to raise money for the company. You can think of issued stocks as a kind of debt you've issued that continuously pay interest over time, except the interest isn't cash or dividends, it's equity in your company as it grows.
If you know your company is in a good place and the stock is undervalued, you could convert that debt so instead of having to pay equity as interest, you pay a dollar amount to a bank. But that tool could also be used to artificially inflate the value of fixed price stock options that may be issued to execs.
Buybacks are one of the bigger ways businesses are doing this because buybacks have significant tax advantages versus dividends. (
So long as management can rely on low interest rates and government bailouts for big businesses, it's hard to argue it's even a management failure. It's a failure of our government to set the correct expectations and fiscal policy.
Also, buybacks absolutely benefit shareholders that continue to hold. The supply of shares decreases, often increasing the value of the held shares.
Levine's argument did implicitly point out to me that there are times when those who don't sell back some of their shares during buybacks are inherently taking on more forward risk than with dividend stocks; a lesson I'm learning now the hard way. One lives and learns.
Taking a step back from "good or bad?"... One thing I haven't seen outside the academic literature is a discussion of the leverage ratchet effect [1]. Buybacks are just one lever that actuates the ratchet. A question worth asking: "why has corporate leverage increased so much over the past 30 years?" I don't claim to have an answer, but asking that question could shed some light on whether buybacks are "good or bad".
[1] https://www.gsb.stanford.edu/faculty-research/working-papers...
I have always assumed that shareholders wouldn't take this into account, but maybe they deserve more credit than I've been giving them.
If they need to be rescued now they should be regulated like other industries that are critical but don't seem to be able to weather crisis on their own (like banks), e.g. minimum cash reserve requirements with stress testing.
A broader question -- can a company that allocates that much capital to preparedness be expected to survive during normal times?
I don't think there is a re-insurer big enough to handle viable pandemic insurance. Such an entity/industry would need to hold >$1T in pure cash right now.
I am of the opinion that they are probably pretty neutral overall to the economy. Their contribution to inequality is more damning of how capital gains are taxed.
The problem is when boards / executives game the system to front-load options to themselves and other trickery and then cash them out.
†And dividends themselves in turn should be irrelevant to your investing decisions:
* https://www.pwlcapital.com/the-irrelevance-of-dividends-stil...
As another replier pointed out: dividends create a tax event if the shares are held in a taxable account (in US: not IRA, not 401(k)).
Sometimes people (pensions, trusts) don't want those types of events and would rather choose when to invoke tax events by selling only when they need to for income purposes.
If a company does buybacks, and even borrows money for them, it might boost their stock in the short term, but it doesn't make their company better long-term, because they aren't investing that money into R&D, and it puts them in a possible cash crunch in the future (ie airlines today).
As a thought experiment, what if instead of the company buying back stock, it's the US government. What if they decide to spent $500 billion buying 10% of every stock out there, instead of giving $1000 to every American citizen b/c of the virus. The first benefits people in the short-term, and doesn't create a taxable event. The second benefits people in the long-term, but might be a taxable event.
Nope, dividends (and buybacks) are irrelevant: only total return matters:
* https://www.pwlcapital.com/the-irrelevance-of-dividends-stil...
AAPL went public in December 1980. It paid dividends from 1987 to 1995. It then restarted in 2012. Steve Jobs returns to Apple in 1997. Somehow I see AAPL rising in value during its non-dividend paying years.
AMZN when public in May 1997, and has never paid a dividend. AMZN has done some share buybacks in its history, but has not since 2012. Somehow I see AMZN rising in value.
See also the history MSFT: somehow it has had a good total return despite not doing buybacks or dividends for most of its existence.
There is no explanatory power in dividends or buybacks when it comes to stock returns:
* https://en.wikipedia.org/wiki/Factor_investing
* https://www.pwlcapital.com/the-irrelevance-of-dividends-stil...
No, the value of an asset is how much you will get for it.
Steve McQueen's 1968 Mustang Fastback from the movie Bullitt has neither dividends nor buybacks, but it was auctioned in January 2020 for US$ 3.4M.
* https://en.wikipedia.org/wiki/Bullitt
Paul Newman's personal "Paul Newman" Rolex Daytona sold for US$ 17.75M:
* https://www.hodinkee.com/articles/paul-newman-rolex-daytona-...
> Eventually they've got to see a return.
They can see a return at any point: sell your shares for more than you bought them for. Boom: capital returns.
Dividends do not matter:
* https://canadiancouchpotato.com/2011/01/18/debunking-dividen...
A dollar in your pocket is a dollar in your pocket regardless of whether it came from dividends or sell your shares:
* https://www.moneysense.ca/magazine-archive/the-income-illusi...
You are performing what is called "mental accounting":
* https://ritholtz.com/1982/11/explaining-investor-preference-...
* https://www.etf.com/sections/index-investor-corner/21413-swe...
"the value of an asset is how much you will get for it."
and the price of an asset is an estimate of its value. projection of future dividend/buybacks is an important part of determining that value. the idea that its irrelevant to pricing is ludicrous.
False choice: a company can do R&D and do buybacks (or dividends).
The capital return is for excess cash that has no internal use. AAPL spent US$ 4.2B (7.9% of revenues) on R&D and had a dividend.
Sometimes there's a limit to how much you can do: companies have a finite number of employees after all, and there are only a finite number of projects that you may be able to handle at one time.
It's just buybacks are considered 'better' because the event is the choice of the seller, and occurs when it is for them. A dividend is 'thrust' upon a shareholder whether they want it or not. (And not investing in dividend-paying companies can be a non-starter: the company in question may be quality one that is worth owning (regardless of dividends, or buybacks)).
The problem is not buybacks or dividends: it is (a) possible executive chicanery, and (b) a lot of the general public not having the means / spare cash to get their foot in the door in investing.
Share buybacks, in theory, signal to the market that management (who possesses inside knowledge) believes the stock is undervalued, which is often a self-fulfilling prophecy...
For this reason alone I struggle to understand why stock buybacks are allowed.
They are a form of returning capital, no different than dividends.
If a company cannot figure out a way to use all the cash it has available internally (e.g., not enough R&D for all the cash), then why shouldn't it be allowed to return the cash to the owner of the company? How many years did AMZN produce 'zero profit' because they were funneling every penny back into the company? Was that a bad decision?
In the US insider trading laws are about misappropriation of information and the victim is the company. The company cannot commit "insider trading" against itself. Insider trading laws in the US are all about "you were entrusted with this information and by using it for your benefit you harmed the company."
For example if you know of a coming acquisition and you buy a bunch of short-dated out of the money call options then you're going to push up the price of the acquisition target and cost the company money. The crime you committed (in the view of the US government) is not "unfair trading" it "theft" in that you gained at the expense of the company.
That said, I don't think share buybacks would be considered any kind of insider trading anywhere in the world.
My issue is that the transaction goes against the concept of a fair market where everyone has equal access to information. When a company buys back stock the market takes it as a "signal" that the shares are undervalued for reasons that are unknown to the public. Maybe management is aware of key information and the shares are indeed undervalued but that isn't always the case. It seems to me that stock buybacks serve a mixed purpose of paying a dividend while also artificially boosting market "confidence" in the short-term.
I'm of the opinion that the market shouldn't be manipulated by subtle hints from management that way.
I will add that in general I am not fond of the limits on direct sharing that seem to be the result of our current approach to securities regulation.
Does not the company have to pre-announced its plan to run a buyback program (both in the amount and time frame)? Does not pre-broadcasting that achieve the result of making sure everyone has the same information?
Executives also have to file ahead of time paperwork to say that they're buying (selling) stock in the company that they run IIRC.
Is that not sufficient to allow the trading public to make decisions on?
My point is that there often isn't any material nonpublic information underlying the buyback so it only serves as a way to juice the stock price in the short-term by manipulating the psychology of the market. It's also worth noting that these transactions were illegal until Rule 10b-18 specifically exempted them from market manipulation and deception rules.
https://www.zerohedge.com/markets/boeing-which-repurchased-o...
So why should these stock buybacks consistently be boosting the share price? Either investors are stupid, or the company is intentionally paying too much for its own stock so that the CEO can get a big bonus.
I know which one sounds more likely to me.
Edit: I suppose there is a third option: maybe the CEOs were assuming the stock price would rise forever, and were hoping to cash in on the speculative bubble, which is less fraudulent but more reckless. I don’t know which one is worse.
The stock price is not correct, it is a cruel joke with very little connection to real economic activity.
Sure, there are funds like the Vision Fund or boutique stat arb funds who still trade individual names, but these are absolutely dwarfed by the size of investments into entire baskets/etfs. The companies in S&P 500 see more liquidity that the entire rest of the US equities combined. And inside that 500, the top 50 again sees more trading than the entire 450 rest combined.
So what happens when the market sells off? Everything becomes correlated. All the idiosyncratic effects are overpowered by the overall selling pressure. There'll be companies hit more than others, but there'll be very few (basically none) big names that will weather the storm completely unscathed. This is the effect of being included in the top 1000-2000 companies in the US. The moment your company gets there, you have to accept that in a crash, your stock will do the same as everything else.
This behavior also ties back to a broader effect in financial markets, namely that in a market stress, correlations spike. All stocks fall, bonds tend to appreciate (hence stocks and bonds become negatively correlated), by definition, volatility goes up everywhere.
Nothing happens. This was examined during the Q4 2018 almost-bear (19.5<20%) market: I am not aware of any data showing that index investors sell off their holdings during these types of events.
Do you have any such data?
I would hazard to guess we'll see something similar for Q1 2020 fund flows: either neutral or net inflow.
I have no number to substantiate this hunch but I believe that that was one of the main reasons why Boeing's shares continued to still remain at a reasonable level even after the MAX debacle, even though under normal circumstances its shares should have seen at least a 50-60% nose-dive immediately after the first signs of corporate malfeasance.
But when almost every big pension fund on the planet has to purchase your shares because it's included in a big index that will never fail of course that the stock market won't "punish" despicable moves like the one committed by Boeing.
The evidence appears to suggest otherwise.
In the previous almost-bear (19.5<20%) of Q4 2018, there were net inflows into index funds.
* https://www.morningstar.com/insights/2019/01/28/us-fund-flow...
While a bit self-serving, Vanguard showing that index funds are not a factor:
* https://www.vanguardcanada.ca/individual/articles/education-...
I'm not necessarily saying that either of these will happen, but there is risk.
Indexes are today's CDSes, it baffled me how many people were defending them (in fact, I'm pretty sure the vast majority of people still defends them in one way or another) when in fact it had been visible for at least 3-4 years that they're the new "too big to fail" thing that will bring the whole edifice down at the first signs of weakness. We never learn, we always like to think that there's some silver bullet in finance that will make us earn money almost for ever with close to no risks.
PE ratios are in the normal range.
How do you justify your position?
What are you comparing it to? RE? RE isn't passive.
Can someone who understands this better explain how it works?
The Quantitative Easing brought rates down to almost zero for a decade. Abundant liquidity, low rate loans.
Corporate management use the chance to get cheap money to buy stocks back. Stock prices go up, the management gets huge payouts. Workers and shareholders get nothing. Inequality grows. R&D expenses decline.
As stock prices go up, stock indexes soar and we witness (kinda) amazing market growth (woo-hoo) which is actually pumped up artificially (who cares).
The virus hits the economy. The stock indexes deflate.
The Fed announces another huge round of QE to "inject liquidity", and we now all know where it will go.
I'm not sure if all this can be better described by "scam" or "corruption".
"Buybacks have been the single largest source of US equity demand each year since 2010, averaging $421 billion annually. In comparison, during this period, average annual equity demand from households, mutual funds, pension funds, and foreign investors was less than $10 billion each."
No one is depriving themselves of needed liquidity. Liquidity-need is forecasted, as is the expected IRR for the cash on hand if it were re-invested into the company. Ultimately, companies decided share holders got the best return with buybacks.
What is happening is executive suite milks the cow to death as fast as possible, because there no adverse consequences for them. They think they will be safe in their bunkers in New Zealand when the shit hits the fan.
"As a group, the six [major US] airlines spent 96% of their free cash flow on stock buybacks over the past 10 full years through 2019."
"Boeing’s free cash flow for 10 years totaled $58.37 billion, while the company spent $43.44 billion, or 74% of free cash flow, on stock repurchases."
https://thenextrecession.wordpress.com/category/profitabilit...
Uhh... well, that math doesn't check out.
Also, how come they’re in trouble if everybody paid for their tickets, and they’re not flying?
Are companies with greater ownership more resilient to market turbulence? Are they better positioned to focus on long term growth over short term performance?
Additionally, it is unclear if these companies were neglecting R&D or had already exhausted their viable options. If the economy does turn for the worse, would additional high risk R&D investments still yield returns? Perhaps they were wise not to park capital in R&D
Last, buybacks allowed a large number of shareholders to cash out while the market was at an all time high.
It is not impossible, however, to exhaust R&D opportunities with an expected NPV greater than zero.
I have seen a lot of great companies acquired and destroyed by parent companies in another industry.
It certainly can and is often done well, but is not trivial or risk free.
acquisitions in general are all too often vanity projects, rather than synergistic value creators they're purported to be.
Also, if something is a good investment, it doesn't mean it is a good investment for a given company.
I worked at a company where annual goals routinely included invest X billion on new technology acquisitions. Some of this money sticks and some doesn't.
Tell that to AAPL: how many projects got cut when Jobs came back to run the company in the 1990s.
Just because you can spend time on something does not mean you should. A company has a finite amount of employess, who have a finite amount of hours of daylight, with competitors nipping at their heels.
And you say
>I would have liked to see the article address the potential advantages of stock buybacks.
That's a different article. That's just 100% something entirely different than this article was ever meant to be. Why would you even make this comment?
It's a different article, for sure. It's also a better written article that favors balanced, thorough arguments over proselytizing.
> Why would you even make this comment?
It's not your job to police other people's comments. I would expect that to be an axiomatic truth, but here we are.
I am receptive and interested in their premise, but don't feel like a robust case was made because no counterclaims were addressed.
I wrote this comment in hopes of discussing the topic with other posters so perhaps we could all expand our understanding of the world we live in.