7 ms·

Why I Don't Like Stock Buybacks

36 points by wheels 16y ago

adamilardi 16y ago
Dividends are much better. Once the market speaks a formerly mighty stock can drop very quickly. I'd rather have the cash now then a slow reduction in supply. After the "great recession crash" we saw how demand can change and even with less supply see huge drops in stock price.
- yummyfajitas 16y ago
  If you prefer dividends, sell shares back to the company in proportion the share buyback. It's mathematically equivalent to dividends (you own the same fraction of the company before and after), but you pay less tax.
  - tocomment 16y ago
    Any references on that? It sounds possible, but I thought I had heard of cases of stock buybacks not increasing the share price. I guess obviously if a company does a buyback but the stock goes down for unrelated reasons then you're really not gaining anything.
    - yummyfajitas 16y ago
      Simple arithmetic. If you hold 100 shares of 100,000 outstanding shares, you own 0.1% of the company. If they buy back 5000 shares and you sell 5 shares, you still own 95 shares of 95,000 outstanding shares (0.1% of the company) + cash. That's exactly what a dividend would do. Silverlake is correct to point out that this doesn't apply to small investors, however.
      - adamilardi 16y ago
        95,000 is not correct those 5000 shares don't disappear. They are still outstanding. The only way I know to decrease shares is a reverse split or increase them via an offering
        yummyfajitas 16y ago
        If the shares are retired, which is what we are discussing in this case, they do disappear.
        adamilardi 16y ago
        Thanks for responding. can you point to me some articles explaining more about retired shares?
    - T_S_ 16y ago
      First semester Corporate Finance. Try Brealey & Myers or Copeland & Weston. The author may have a point that he was signaling they had nothing better to do with the funds. But, it's hard to say the share price would not have been worse, since this happened in a downtrending market. There is a potential confounding fallacy in that the author doesn't seem to get.
    - pbhjpbhj 16y ago
      >I guess obviously if a company does a buyback but the stock goes down for unrelated reasons then you're really not gaining anything. Unless they held the stock above the falling trend. I felt this was a potential flaw in the analysis - the stock price kept falling but that was not necessarily related and could have crashed completely if it weren't for the buyback, we can't tell; it's not science.
  - silverlake 16y ago
    For small investors (< 1000 shares), the transaction cost will be higher than the tax on dividends.
  - adamilardi 16y ago
    It's not mathematically equivalent because a share buyback comes from the open market. The # of shares don't decrease with a buyback
yummyfajitas 16y ago
But I don't view that stock buyback as successful.[...]But we let the cash sit in the bank and worse we gave a lot of it back to investors in a manner that did not do much for the company. Cash for investors? But doing nothing for the company? That's a good thing and more companies should do this. The sole purpose of the company is [1] to increase shareholder value. If reinvesting in the company would bring above-market returns, then it's a good idea to do. If not, corporate leadership should increase shareholder value with cash rather than building an empire with other people's money. [1] I ignore nonprofits and corporations with special clauses in their charter.
- yoseph 16y ago
  Couldn't agree more re increasing shareholder value. Also, a share buyback signals to investors that the company believes its shares are undervalued.
- davidw 16y ago
  I think the point is that if you're a startuppish company, you should still have "places to go" with your money in the bank rather than being "out of ideas", like RIM apparently is, as he mentions at the end.
  - timwiseman 16y ago
    You are completely right, but very few "startuppish" companies do buybacks. In fact, depending on how you draw the lines very few "startuppish" companies are publicly traded. It is possible for a more mature company to have truly reached market saturation in their area. Then they are left with the option of investing in R&D to try to make something truly new, trying to branch out outside of their current area, or distributing the profits to shareholders. These three stategies are not mutually exclusive and a company with sufficient profits can do all three. But both R&D and diverisifying can involving risking the money put into them (potentially even more than you put into them when you consider liability possibilities), so it can make a lot of sense for a mature company to directly enrish the shareholders, and a stock buyback is one way of doing that.
- 16y ago
T_S_ 16y ago
"I didn't understand what was going on. We had more cash than it would take to buy back every share in the company and yet the stock kept going down." Obvious exaggeration. How many companies have more cash than market cap? Only ones that owe the money to someone else and cannot use it to buy back their stock. That made me question the whole article.
- pmjordan 16y ago
  How may companies have more cash than market cap? It doesn't seem that implausible after a stock market crash.
- philk 16y ago
  It happens from time to time, mostly after market bubbles burst these days. It used[1] to happen a bit more often because information wasn't as readily available. [1] ie decades ago...
- jakarta 16y ago
  Screening for negative enterprise value (Market Cap + Debt - Cash) is pretty popular. There aren't a whole lot of stocks that have it, but you can usually find a handful based in the US. They are sort of an inefficiency. In one sense, you are buying a stock for less than the cash on balance sheet. You could come in and liquidate it, making a profit. On the other side, sometimes stocks trade at negative EV because management is doing some terrible things. Maybe they are burning through cash at an alarming rate. Sometimes an activist will come in and stop the cash burn. I would also like to add that you can find negative EV stocks abroad more readily. There was a period when these opportunities existed in Korea (I think around 2004). It was pretty amazing if you were an investor.
philk 16y ago
I think he's missing the point. When a stock is trading below its tangible book value each share of stock bought back delivers increased value per share to the remaining stockholders. The only reason not to buy back shares if they're trading below tangible book value [1] is because you have investments available that will yield greater returns, or do not have sufficient cash to do so. [1] Factoring in a margin of safety, of course.
- meterplech 16y ago
  He realizes your point- he remarks "We just gave back a lot of cash to the investors." His point is that companies that can't find better ways to use capital than a buy back aren't innovative enough to succeed in the long term
  - philk 16y ago
    No he doesn't. From the article: Stock buybacks are very popular with some investors as a way for a company to transfer value from the company back to the shareholders. It is like a dividend, except it is taxed as a capital gain, not ordinary income. He's approaching it from the opposite direction; ie returning value to investors who are selling their stock. But if the company is truly worth more per share, in terms of tangible book value, than the price the shares are trading at then anyone who is selling up is getting a bad deal. These people aren't getting value. It's the people who retain their stock who are getting value because they're managing to buy slices of a company worth $(X+Y) for only $X. A simplified example: FictionCorp has $200 million in the bank and 100 million shares outstanding. For some reason, the shares are trading at $1, despite the $2/share sitting in the bank. If FictionCorp manages to go and buy back half its stock at $1/share, it now has $150 million in the bank but only 50 million outstanding shares. Each share now represents $3 worth of cash in FictionCorp's bank account. Hence, the remaining stockholders are better off because they've managed to buy a larger portion of FictionCorp at a discount to its actual value.
    - yummyfajitas 16y ago
      It's highly unlikely that FictionCorp will manage to buy half it's stock without moving the markets. Most shareholders who sell will get significantly more than $1/share.
Sukotto 16y ago
Personally, I wish they would spend that money on making their email client display html well. It sucks for emailing tabular data to business owners. They could also greatly improve their web browser. Apple's devices totally eat RIM's lunch when it comes to browsing.
byrneseyeview 16y ago
[A]fter the market broke in early 2000, the stock was trading below its cash value... I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. If you're buying a dollar bill for 90 cents, and someone offers you a dollar bill for 80 cents, you didn't lose money. I disagree with this post. If TSCM was trading at less than net cash, a buyback meant that they were getting paid to own more of it. That's an incredible deal. Also, they did something that would gave the business a temporarily negative market value (i.e. cash plus business is worth less than cash alone)--and they thus should have invested more cash in the business? That doesn't make sense. Either the stock market was right, TSCM was worth liquidation value, and the buyback was a way to gradually liquidate the company... or the market was wrong, the TSCM business was worth more than the stock's market price, and buying back the stock was a great move.
skybrian 16y ago
If you assume no more profits and a fixed cost to winding the company down (you can't actually get all the cash back) then buying back stack reduces the cash to required expenses ratio, so it would make sense for the stock price to go down. At the point where cash equals the remaining expenses then the stock is worth zero. But this shouldn't happen for a profitable company, even if they are "out of ideas".
meric 16y ago
Companies perform stock buy backs when they don't have any ideas in how to invest their cash. A recent example is an Australian company called "CSL". A year or so ago it held a massive share raising and was proposing to use the cash to buy out a US pharmaceutical firm. The US regulator thought it would give CSL too much market power and stopped the deal from happening. What CSL did was initiate a stock buy back to return the cash to investors. Link: http://www.theaustralian.com.au/business/wealth/upside-for-csl-investors-share-buyback/story-e6frgacx-1225715690408 http://www.theaustralian.com.au/business/wealth/upside-for-c... It's not necessarily not good.
damoncali 16y ago
Fred is just wrong on this. Companies exist to enrich the shareholders. A buyback is very much like a dividend, and should be viewed similarly. Is he saying that companies shouldn't pay dividends? That's insane. A company with too much cash is wasting it's investors' money.
- pbhjpbhj 16y ago
  I thought he was basically bemoaning the capitalist carrion call "Companies exist to enrich the shareholders." and suggesting that there was greater worth available in investing the monies rather than handing more profits back to shareholders.
- fredwilson 16y ago
  Damon I like dividends for mature cash flowing businesses who cannot find a good use of their cash Fred
  - d2viant 16y ago
    Yes, but you're paying a hefty price to get your money that way -- mainly the double taxation on dividends. Stock buybacks can be a more efficient way of returning that cash to shareholders.
  - damoncali 16y ago
    Fair enough. But it sounds like what you're really saying is that you prefer growing companies to mature companies, not that buybacks are intrinsically bad.
joubert 16y ago
It would be interesting to see the writer debate share buybacks with Buffet.
Nwallins 16y ago
I don't understand this point: > I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. It seems to me that if your stock is trading at under book value, then you would be underpaying if you are buying it. Especially if it keeps going down. Isn't the idea that the stock is undervalued? Why not buy low now and even consider selling high at a later date?

36 points by wheels 16y ago

Dividends are much better. Once the market speaks a formerly mighty stock can drop very quickly. I'd rather have the cash now then a slow reduction in supply. After the "great recession crash" we saw how demand can change and even with less supply see huge drops in stock price.

yummyfajitas 16y ago
If you prefer dividends, sell shares back to the company in proportion the share buyback. It's mathematically equivalent to dividends (you own the same fraction of the company before and after), but you pay less tax.
- tocomment 16y ago
  Any references on that? It sounds possible, but I thought I had heard of cases of stock buybacks not increasing the share price. I guess obviously if a company does a buyback but the stock goes down for unrelated reasons then you're really not gaining anything.
  - yummyfajitas 16y ago
    Simple arithmetic. If you hold 100 shares of 100,000 outstanding shares, you own 0.1% of the company. If they buy back 5000 shares and you sell 5 shares, you still own 95 shares of 95,000 outstanding shares (0.1% of the company) + cash. That's exactly what a dividend would do. Silverlake is correct to point out that this doesn't apply to small investors, however.
    - adamilardi 16y ago
      95,000 is not correct those 5000 shares don't disappear. They are still outstanding. The only way I know to decrease shares is a reverse split or increase them via an offering
      - yummyfajitas 16y ago
        If the shares are retired, which is what we are discussing in this case, they do disappear.
      - adamilardi 16y ago
        Thanks for responding. can you point to me some articles explaining more about retired shares?
  - T_S_ 16y ago
    First semester Corporate Finance. Try Brealey & Myers or Copeland & Weston. The author may have a point that he was signaling they had nothing better to do with the funds. But, it's hard to say the share price would not have been worse, since this happened in a downtrending market. There is a potential confounding fallacy in that the author doesn't seem to get.
  - pbhjpbhj 16y ago
    >I guess obviously if a company does a buyback but the stock goes down for unrelated reasons then you're really not gaining anything. Unless they held the stock above the falling trend. I felt this was a potential flaw in the analysis - the stock price kept falling but that was not necessarily related and could have crashed completely if it weren't for the buyback, we can't tell; it's not science.
- silverlake 16y ago
  For small investors (< 1000 shares), the transaction cost will be higher than the tax on dividends.
- adamilardi 16y ago
  It's not mathematically equivalent because a share buyback comes from the open market. The # of shares don't decrease with a buyback

yummyfajitas 16y ago

But I don't view that stock buyback as successful.[...]But we let the cash sit in the bank and worse we gave a lot of it back to investors in a manner that did not do much for the company. Cash for investors? But doing nothing for the company? That's a good thing and more companies should do this. The sole purpose of the company is [1] to increase shareholder value. If reinvesting in the company would bring above-market returns, then it's a good idea to do. If not, corporate leadership should increase shareholder value with cash rather than building an empire with other people's money. [1] I ignore nonprofits and corporations with special clauses in their charter.

yoseph 16y ago
Couldn't agree more re increasing shareholder value. Also, a share buyback signals to investors that the company believes its shares are undervalued.
davidw 16y ago
I think the point is that if you're a startuppish company, you should still have "places to go" with your money in the bank rather than being "out of ideas", like RIM apparently is, as he mentions at the end.
- timwiseman 16y ago
  You are completely right, but very few "startuppish" companies do buybacks. In fact, depending on how you draw the lines very few "startuppish" companies are publicly traded. It is possible for a more mature company to have truly reached market saturation in their area. Then they are left with the option of investing in R&D to try to make something truly new, trying to branch out outside of their current area, or distributing the profits to shareholders. These three stategies are not mutually exclusive and a company with sufficient profits can do all three. But both R&D and diverisifying can involving risking the money put into them (potentially even more than you put into them when you consider liability possibilities), so it can make a lot of sense for a mature company to directly enrish the shareholders, and a stock buyback is one way of doing that.
16y ago

T_S_ 16y ago

"I didn't understand what was going on. We had more cash than it would take to buy back every share in the company and yet the stock kept going down." Obvious exaggeration. How many companies have more cash than market cap? Only ones that owe the money to someone else and cannot use it to buy back their stock. That made me question the whole article.

pmjordan 16y ago
How may companies have more cash than market cap? It doesn't seem that implausible after a stock market crash.
philk 16y ago
It happens from time to time, mostly after market bubbles burst these days. It used[1] to happen a bit more often because information wasn't as readily available. [1] ie decades ago...
jakarta 16y ago
Screening for negative enterprise value (Market Cap + Debt - Cash) is pretty popular. There aren't a whole lot of stocks that have it, but you can usually find a handful based in the US. They are sort of an inefficiency. In one sense, you are buying a stock for less than the cash on balance sheet. You could come in and liquidate it, making a profit. On the other side, sometimes stocks trade at negative EV because management is doing some terrible things. Maybe they are burning through cash at an alarming rate. Sometimes an activist will come in and stop the cash burn. I would also like to add that you can find negative EV stocks abroad more readily. There was a period when these opportunities existed in Korea (I think around 2004). It was pretty amazing if you were an investor.

philk 16y ago

I think he's missing the point. When a stock is trading below its tangible book value each share of stock bought back delivers increased value per share to the remaining stockholders. The only reason not to buy back shares if they're trading below tangible book value [1] is because you have investments available that will yield greater returns, or do not have sufficient cash to do so. [1] Factoring in a margin of safety, of course.

meterplech 16y ago
He realizes your point- he remarks "We just gave back a lot of cash to the investors." His point is that companies that can't find better ways to use capital than a buy back aren't innovative enough to succeed in the long term
- philk 16y ago
  No he doesn't. From the article: Stock buybacks are very popular with some investors as a way for a company to transfer value from the company back to the shareholders. It is like a dividend, except it is taxed as a capital gain, not ordinary income. He's approaching it from the opposite direction; ie returning value to investors who are selling their stock. But if the company is truly worth more per share, in terms of tangible book value, than the price the shares are trading at then anyone who is selling up is getting a bad deal. These people aren't getting value. It's the people who retain their stock who are getting value because they're managing to buy slices of a company worth $(X+Y) for only $X. A simplified example: FictionCorp has $200 million in the bank and 100 million shares outstanding. For some reason, the shares are trading at $1, despite the $2/share sitting in the bank. If FictionCorp manages to go and buy back half its stock at $1/share, it now has $150 million in the bank but only 50 million outstanding shares. Each share now represents $3 worth of cash in FictionCorp's bank account. Hence, the remaining stockholders are better off because they've managed to buy a larger portion of FictionCorp at a discount to its actual value.
  - yummyfajitas 16y ago
    It's highly unlikely that FictionCorp will manage to buy half it's stock without moving the markets. Most shareholders who sell will get significantly more than $1/share.

Sukotto 16y ago

Personally, I wish they would spend that money on making their email client display html well. It sucks for emailing tabular data to business owners. They could also greatly improve their web browser. Apple's devices totally eat RIM's lunch when it comes to browsing.

byrneseyeview 16y ago

[A]fter the market broke in early 2000, the stock was trading below its cash value... I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. If you're buying a dollar bill for 90 cents, and someone offers you a dollar bill for 80 cents, you didn't lose money. I disagree with this post. If TSCM was trading at less than net cash, a buyback meant that they were getting paid to own more of it. That's an incredible deal. Also, they did something that would gave the business a temporarily negative market value (i.e. cash plus business is worth less than cash alone)--and they thus should have invested more cash in the business? That doesn't make sense. Either the stock market was right, TSCM was worth liquidation value, and the buyback was a way to gradually liquidate the company... or the market was wrong, the TSCM business was worth more than the stock's market price, and buying back the stock was a great move.

skybrian 16y ago

If you assume no more profits and a fixed cost to winding the company down (you can't actually get all the cash back) then buying back stack reduces the cash to required expenses ratio, so it would make sense for the stock price to go down. At the point where cash equals the remaining expenses then the stock is worth zero. But this shouldn't happen for a profitable company, even if they are "out of ideas".

meric 16y ago

Companies perform stock buy backs when they don't have any ideas in how to invest their cash. A recent example is an Australian company called "CSL". A year or so ago it held a massive share raising and was proposing to use the cash to buy out a US pharmaceutical firm. The US regulator thought it would give CSL too much market power and stopped the deal from happening. What CSL did was initiate a stock buy back to return the cash to investors. Link: http://www.theaustralian.com.au/business/wealth/upside-for-csl-investors-share-buyback/story-e6frgacx-1225715690408 http://www.theaustralian.com.au/business/wealth/upside-for-c... It's not necessarily not good.

damoncali 16y ago

Fred is just wrong on this. Companies exist to enrich the shareholders. A buyback is very much like a dividend, and should be viewed similarly. Is he saying that companies shouldn't pay dividends? That's insane. A company with too much cash is wasting it's investors' money.

pbhjpbhj 16y ago
I thought he was basically bemoaning the capitalist carrion call "Companies exist to enrich the shareholders." and suggesting that there was greater worth available in investing the monies rather than handing more profits back to shareholders.
fredwilson 16y ago
Damon I like dividends for mature cash flowing businesses who cannot find a good use of their cash Fred
- d2viant 16y ago
  Yes, but you're paying a hefty price to get your money that way -- mainly the double taxation on dividends. Stock buybacks can be a more efficient way of returning that cash to shareholders.
- damoncali 16y ago
  Fair enough. But it sounds like what you're really saying is that you prefer growing companies to mature companies, not that buybacks are intrinsically bad.

joubert 16y ago

It would be interesting to see the writer debate share buybacks with Buffet.

Nwallins 16y ago

I don't understand this point: > I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. It seems to me that if your stock is trading at under book value, then you would be underpaying if you are buying it. Especially if it keeps going down. Isn't the idea that the stock is undervalued? Why not buy low now and even consider selling high at a later date?