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I get your rationale, but you have to remember that this hypothetical company would probably generate a fair amount of cash. The question then becomes, what do

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

tboyd47 8y ago
I guess I don't understand the mindset in which having extra cash is some sort of problem to solve. Apple, Microsoft, Cisco, Oracle, Qualcomm, etc. all have large stockpiles of cash and no one thinks of them as hedge funds, right?
- nostrademons 8y ago
  Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly. Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.
  - paulddraper 8y ago
    Yes, though most of the purchase is usually paid in stock. They didn't just write a check for $19B.
    - nostrademons 8y ago
      Usually true, but they want the optionality of being able to purchase in cash if the buyer demands it. DoubleClick ($3.1B) and Motorola ($12.5B) were both purchased for cash. Not many buyers have $12B in cash sitting around.
      - deleted 8y ago
        [deleted]
- pmart123 8y ago
  Apple actually does have a quasi hedge fund to manage its cash position: https://qz.com/393093/the-mysterious-fund-in-the-desert-that-manages-apples-cash/ https://qz.com/393093/the-mysterious-fund-in-the-desert-that... Too much cash can also lead to behavioral finance issues down the road as well such as companies making ill-fated acquisitions such as Microsoft did under Ballmer's helm.
  - tboyd47 8y ago
    Excuse me if this sounds tongue-in-cheek, but is "behavioral finance issues" another way to say that the people placed in charge of the large pile of cash can't be trusted with it? Are you saying the solution to that is to just not to hold any cash?
  - longerthoughts 8y ago
    That fund does not remotely resemble a hedge fund. They strictly invest in low-risk securities (e.g. highly rated government bonds) to generate a modest return and minimize loss against inflation.
rightbyte 8y ago
Why not give the cash to the owners. That's what stocks are for, right. Doesn't seem like a problem at all. A "low growth" company is a stable company. High growth is high risk.
- stilky 8y ago
  That's essentially what a stock buyback does. The two options to return earnings to the owners are to issue a dividend, which is taxed at a higher rate or to buy back stock which drives up the value of outstanding shares thus returning value to the shareholders
  - tboyd47 8y ago
    I've read this explanation (two equivalent choices, one is taxed higher than the other) so many times, but I can't believe there's no downside to stock buybacks. Something about it just feels very wasteful, like picking the fruits of a tree just to grind them into compost for the soil under the same tree.
    - longerthoughts 8y ago
      >like picking the fruits of a tree just to grind them into compost for the soil under the same tree The difference being that your example would at least enrich the soil and potentially improve future yields (like R&D), while buybacks are essentially just propping up the stock price with no fundamental contribution to future success.
    - kd5bjo 8y ago
      Buybacks only return money to shareholders who choose to sell. Instead of distributing the company’s profits proportionally to its owners, it becomes a game of chicken as each investor has to decide when they should get out.

tboyd47 8y ago

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

nostrademons 8y ago
Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly. Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.
- paulddraper 8y ago
  Yes, though most of the purchase is usually paid in stock. They didn't just write a check for $19B.
  - nostrademons 8y ago
    Usually true, but they want the optionality of being able to purchase in cash if the buyer demands it. DoubleClick ($3.1B) and Motorola ($12.5B) were both purchased for cash. Not many buyers have $12B in cash sitting around.
    - deleted 8y ago
      [deleted]
pmart123 8y ago
Apple actually does have a quasi hedge fund to manage its cash position: https://qz.com/393093/the-mysterious-fund-in-the-desert-that-manages-apples-cash/ https://qz.com/393093/the-mysterious-fund-in-the-desert-that... Too much cash can also lead to behavioral finance issues down the road as well such as companies making ill-fated acquisitions such as Microsoft did under Ballmer's helm.
- tboyd47 8y ago
  Excuse me if this sounds tongue-in-cheek, but is "behavioral finance issues" another way to say that the people placed in charge of the large pile of cash can't be trusted with it? Are you saying the solution to that is to just not to hold any cash?
- longerthoughts 8y ago
  That fund does not remotely resemble a hedge fund. They strictly invest in low-risk securities (e.g. highly rated government bonds) to generate a modest return and minimize loss against inflation.

rightbyte 8y ago

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

stilky 8y ago
That's essentially what a stock buyback does. The two options to return earnings to the owners are to issue a dividend, which is taxed at a higher rate or to buy back stock which drives up the value of outstanding shares thus returning value to the shareholders
- tboyd47 8y ago
  I've read this explanation (two equivalent choices, one is taxed higher than the other) so many times, but I can't believe there's no downside to stock buybacks. Something about it just feels very wasteful, like picking the fruits of a tree just to grind them into compost for the soil under the same tree.
  - longerthoughts 8y ago
    >like picking the fruits of a tree just to grind them into compost for the soil under the same tree The difference being that your example would at least enrich the soil and potentially improve future yields (like R&D), while buybacks are essentially just propping up the stock price with no fundamental contribution to future success.
  - kd5bjo 8y ago
    Buybacks only return money to shareholders who choose to sell. Instead of distributing the company’s profits proportionally to its owners, it becomes a game of chicken as each investor has to decide when they should get out.