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Stock buybacks are dangerous for the economy

305 points by peer2pay 7y ago

missedthecue 7y ago
I'm surprised this came from the HBR. They said only 43% of companies record R&D expense but almost all buy back stock. 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.
- thereisnospork 7y ago
  I thought there were some reasonably strong tax incentives for capitalizing R+D - which would presumably lead to a high disclosure rate?
  - airstrike 7y ago
    Under U.S. GAAP most R&D has to be expensed, not capitalized IFRS is a different beast but even then not every R&D can be capitalized
- 3pt14159 7y ago
  I'm not surprised. I've never thought HBR had high quality stuff. This sentence alone is ridiculous: > 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.
  - ericd 7y ago
    It can also be done to put executive options in the money...
  - jsight 7y ago
    I agree, and I think Apple is an example of a company that uses debt in a perfectly sensible way. 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.
    - airstrike 7y ago
      > 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) 1. https://en.wikipedia.org/wiki/Agency_cost https://en.wikipedia.org/wiki/Agency_cost
ISL 7y ago
Matt Levine has a rebuttal to this argument today. 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.
- rmrfstar 7y ago
  Thanks for pointing out a rebuttal. 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/leverage-ratchet-effect https://www.gsb.stanford.edu/faculty-research/working-papers...
- scott_s 7y ago
  The value increase caused by the buyback tends to disappear in a year or so. There was a study which found this, but I don’t have a reference on hand.
  - AznHisoka 7y ago
    Which makes sense, because usually the buy back happens during a limited period less than a year.
  - jsight 7y ago
    I do not understand why that would happen. Wouldn't they inflate the earnings per share, resulting in a permanently higher share price (all else being equal)?
    - dlp211 7y ago
bsamuels 7y ago
The point about executive compensation is probably the most poignant. 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.
ortusdux 7y ago
I would say that the airline industry regrets spending 96% of their free cash over the ~last decade buybacks, but it looks like they are probably going to get bailed out...
- jbverschoor 7y ago
  So they can issue back those shares on the market
  - AznHisoka 7y ago
    But don't buybacks usually mean they bought back the shares and eliminated them? It no longer exists. It's not sitting in any account.
    - airstrike 7y ago
      Stock that is bought back is called "Treasury stock", and it can either be retired or held for resale in the market https://www.investopedia.com/terms/t/treasurystock.asp https://www.investopedia.com/terms/t/treasurystock.asp
    - jbverschoor 7y ago
      They can issue new shares if they want. Also, how come they’re in trouble if everybody paid for their tickets, and they’re not flying?
      - jandrese 7y ago
        Airlines have been issuing refunds. Also, new bookings have fallen off of a cliff.
        jbverschoor 7y ago
        Interesting
      - kgwgk 7y ago
AnthonyMouse 7y ago
High corporate debt isn't caused by buybacks, it's caused by low interest rates. Low interest rates cause buybacks because it becomes more attractive to raise capital through borrowing than selling shares. 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.
- magicnubs 7y ago
  > now is the time to print a bunch of new money 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.
  - AnthonyMouse 7y ago
    It isn't really mortgage banks that lose out from inflation. The money banks loan you is created from nothing as a fiction inside their computers and destroyed again when you pay it back. The only money that continues to exist is the interest you paid them, which they get to keep. 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.
magicnubs 7y ago
Is this part of why stocks have slipped so much? Based on what I know of the market (what relatively little I know, I keep up with it, but it's not my day job), I'd have expected most of the volatility from coronavirus to be in the sectors most heavily affected by low foot-traffic. Instead companies like Google and Apple are down 30%. I doubt the anyone is seriously expecting COVID-19 to cause the average of Google's or Apple's profits over the next 20 years to fall by 30%, so it seems the market must have been oversubscribed? Maybe it still is. The S&P500 is still at a historically relatively high PE of 18.5 and a Schiller CAPE of 23.2, both of which will probably be even higher after earnings are announced next month.
- deleted 7y ago
  [deleted]
- AznHisoka 7y ago
  A lot of trading is done via indexes. So if people are bearish, the whole market ends up tanking. Stocks like Roku and Netflix should actually benefit from people staying home, but their stock is still going down, because people are just selling the entire index.
  - short_sells_poo 7y ago
    You are correct and this effect is increasing over time. More and more investment is being done on baskets of stocks as these investments became accessible through ETFs and traditional managers were not able to beat the "dumb" indices (there's nothing really dumb about them). 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.
legitster 7y ago
HBR also has published a few rebuttals of this same argument: https://hbr.org/2018/03/are-buybacks-really-shortchanging-investment https://hbr.org/2018/03/are-buybacks-really-shortchanging-in... 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.
s1artibartfast 7y ago
I would have liked to see the article address the potential advantages of stock buybacks. 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.
- digitaltrees 7y ago
  It’s literally impossible to exhaust R&D Opportunities. The hard part is going from research to commercialization but the is an almost unlimited amount of innovation still possible.
  - airstrike 7y ago
    > It’s literally impossible to exhaust R&D Opportunities. It is not impossible, however, to exhaust R&D opportunities with an expected NPV greater than zero.
    - clairity 7y ago
      that's only limited by how you define the industry you're in. we'd have a lot more to worry about if no NPV positive opportunities existed at all (which would imply an exhaustion of relatively free raw inputs).
      - s1artibartfast 7y ago
        >that's only limited by how you define the industry you're in. 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.
throw0101a 7y ago
Stock buybacks are no different than dividends†: a form of returning capital to the owners / investors of a company. 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-still-a-non-starter/ https://www.pwlcapital.com/the-irrelevance-of-dividends-stil...
- amiga_500 7y ago
  So why not just issue dividends and avoid the downsides?
  - jdminhbg 7y ago
    The tax code penalizes dividends by taxing recipients at the time they're paid.
    - dlp211 7y ago
      The same "penalty" applies to the capital gains realized by the sellers when the buyback happens and future sales. The only substantial difference is the ability to choose when to realize those gains by the other shareholders. It's a bad argument and buy backs should be made illegal again.
  - throw0101a 7y ago
    > So why not just issue dividends and avoid the downsides? 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.
    - AznHisoka 7y ago
      But so what if it creates a taxable event? Let's put aside what is good for you in the short-term, for a second. 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.
mannykannot 7y ago
Is a company with cash on hand and low debt at risk of a leveraged buyout, leading (if it happens) to high debt and a low reserve anyway?
ogre_codes 7y ago
Anytime a company overextends itself financially, it's dangerous for the company and if lots of companies do it, the economy as a whole. Look at PG&E underinvesting in infrastructure while paying large dividends, it's the exact same problem. Companies have become micro-focused on short term returns for shareholders and lost track of longer term planning and building anti-fragilility into the company infrastructure. 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.
cornishpixels 7y ago
> In 2018 alone, even with after-tax profits at record levels because of the Republican tax cuts, buybacks by S&P 500 companies reached an astounding 68% of net income, with dividends absorbing another 41%. Uhh... well, that math doesn't check out.
- ascagnel_ 7y ago
  It's saying that the S&P 500 companies spent a total of 109% of their income on buybacks and dividends, intentionally and voluntarily running at a loss to increase stock prices (vs. running at a loss to grow revenues or something similar).
IanDrake 7y ago
>When companies do these buybacks, they deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn. 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.
- pauljurczak 7y ago
  Really? So why they are asking for a bailout now if they had not deprived themselves of needed liquidity? Have they not noticed the cyclical nature of economy? 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.
  - IanDrake 7y ago
    Who took on more debt just for stock buyback that is now asking for a bailout?
    - pauljurczak 7y ago
      It's not necessarily about taking debt to buyback their stock. It is about free cash flow. Here are some facts: "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."
fallingfrog 7y ago
Here’s the thing: if a company has 1 million dollars in cash, and a 2 million dollar market cap, and they spend the cash buying back 1 million worth of stock, the total value of the company, including the cash they spent, has decreased by 1 million dollars and the stock price should therefore not change at all. 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.
- exoque 7y ago
  The stock price should change because the earnings per share will be higher in the future.
  - fallingfrog 7y ago
    But the company is poorer by the same amount as they spent on stocks, which if the stock price is correct should reduce earnings by the same amount, canceling out to no change in the stock price.
    - pauljurczak 7y ago
      > if the stock price is correct The stock price is not correct, it is a cruel joke with very little connection to real economic activity.
      - fallingfrog 7y ago
        My point exactly
    - exoque 7y ago
      Yes, the market cap of the company is lowered by the amount it spends on the buy back, however the value per share stays the same. A year later the profit from the new year is included in the market cap which is divided by a lowet number of shares. This means the value of a single share is now higher while the market cap is the same as in the beginning. Or am i missing something?
acd 7y ago
Would it be so that stock buy backs amplify the company stock value during good times? But is the reverse true when there is a down turn in the market? Ie when there is a market down turn if a company owns its own stock it amplifies the down movement? Can someone who understands this better explain how it works?
crazygringo 7y ago
> 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. 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.
- dlp211 7y ago
  American airliners returned 96% of their profit as share buybacks and are now requesting a $50 billion bailout and you still want to defend borrowing money to finance buybacks, which were illegal until sometime in the 1980's. 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.
  - jsanford9292 7y ago
    I am sorry to say that I agree and, to be effective, capitalism needs to work much like natural selection. 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.
    - 7y ago
OscarCunningham 7y ago
Can't companies just take on debt now, to avoid bankruptcy? Lenders should be eager to lend to them because they know that business will return to normal after the virus has passed.
mhb 7y ago
"Boeing, Which Repurchased over $100B in Stock, Downgraded to BBB, Seeks Bailout" https://www.zerohedge.com/markets/boeing-which-repurchased-over-100bn-stock-downgraded-bbb-seeks-short-term-bailout https://www.zerohedge.com/markets/boeing-which-repurchased-o...
deleted 7y ago
[deleted]
bitxbit 7y ago
I am shocked how many companies were so thinly spread after ‘08 and the virus exposed them. We learned absolutely nothing from 2008 (probably because the govt bailed out everyone). Does capitalism really work when we can’t even enforce true price discovery?
dgudkov 7y ago
Fascinating. Correct me if I'm getting it wrong: 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".
chris123 7y ago
They're means to transfer wealth to the executives and risk too everyone else. Simple as that.
jganetsk 7y ago
Maybe it's just profitability is dangerous for the economy. https://thenextrecession.wordpress.com/category/profitability/ https://thenextrecession.wordpress.com/category/profitabilit...
pauljurczak 7y ago
To underline huge market distorting impact of stock buyback, read this quote from Goldman Sachs Top of Mind, Issue #77 (https://www.goldmansachs.com/insights/pages/top-of-mind/buyback-realities/report.pdf https://www.goldmansachs.com/insights/pages/top-of-mind/buyb...): "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."

305 points by peer2pay 7y ago

I'm surprised this came from the HBR. They said only 43% of companies record R&D expense but almost all buy back stock. 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.

thereisnospork 7y ago
I thought there were some reasonably strong tax incentives for capitalizing R+D - which would presumably lead to a high disclosure rate?
- airstrike 7y ago
  Under U.S. GAAP most R&D has to be expensed, not capitalized IFRS is a different beast but even then not every R&D can be capitalized
3pt14159 7y ago
I'm not surprised. I've never thought HBR had high quality stuff. This sentence alone is ridiculous: > 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.
- ericd 7y ago
  It can also be done to put executive options in the money...
- jsight 7y ago
  I agree, and I think Apple is an example of a company that uses debt in a perfectly sensible way. 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.
  - airstrike 7y ago
    > 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) 1. https://en.wikipedia.org/wiki/Agency_cost https://en.wikipedia.org/wiki/Agency_cost

ISL 7y ago

Matt Levine has a rebuttal to this argument today. 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.

rmrfstar 7y ago
Thanks for pointing out a rebuttal. 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/leverage-ratchet-effect https://www.gsb.stanford.edu/faculty-research/working-papers...
scott_s 7y ago
The value increase caused by the buyback tends to disappear in a year or so. There was a study which found this, but I don’t have a reference on hand.
- AznHisoka 7y ago
  Which makes sense, because usually the buy back happens during a limited period less than a year.
- jsight 7y ago
  I do not understand why that would happen. Wouldn't they inflate the earnings per share, resulting in a permanently higher share price (all else being equal)?
  - dlp211 7y ago

bsamuels 7y ago

The point about executive compensation is probably the most poignant. 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.

ortusdux 7y ago

I would say that the airline industry regrets spending 96% of their free cash over the ~last decade buybacks, but it looks like they are probably going to get bailed out...

jbverschoor 7y ago
So they can issue back those shares on the market
- AznHisoka 7y ago
  But don't buybacks usually mean they bought back the shares and eliminated them? It no longer exists. It's not sitting in any account.
  - airstrike 7y ago
    Stock that is bought back is called "Treasury stock", and it can either be retired or held for resale in the market https://www.investopedia.com/terms/t/treasurystock.asp https://www.investopedia.com/terms/t/treasurystock.asp
  - jbverschoor 7y ago
    They can issue new shares if they want. Also, how come they’re in trouble if everybody paid for their tickets, and they’re not flying?
    - jandrese 7y ago
      Airlines have been issuing refunds. Also, new bookings have fallen off of a cliff.
      - jbverschoor 7y ago
        Interesting
    - kgwgk 7y ago

AnthonyMouse 7y ago

High corporate debt isn't caused by buybacks, it's caused by low interest rates. Low interest rates cause buybacks because it becomes more attractive to raise capital through borrowing than selling shares. 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.

magicnubs 7y ago
> now is the time to print a bunch of new money 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.
- AnthonyMouse 7y ago
  It isn't really mortgage banks that lose out from inflation. The money banks loan you is created from nothing as a fiction inside their computers and destroyed again when you pay it back. The only money that continues to exist is the interest you paid them, which they get to keep. 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.

magicnubs 7y ago

Is this part of why stocks have slipped so much? Based on what I know of the market (what relatively little I know, I keep up with it, but it's not my day job), I'd have expected most of the volatility from coronavirus to be in the sectors most heavily affected by low foot-traffic. Instead companies like Google and Apple are down 30%. I doubt the anyone is seriously expecting COVID-19 to cause the average of Google's or Apple's profits over the next 20 years to fall by 30%, so it seems the market must have been oversubscribed? Maybe it still is. The S&P500 is still at a historically relatively high PE of 18.5 and a Schiller CAPE of 23.2, both of which will probably be even higher after earnings are announced next month.

deleted 7y ago
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AznHisoka 7y ago
A lot of trading is done via indexes. So if people are bearish, the whole market ends up tanking. Stocks like Roku and Netflix should actually benefit from people staying home, but their stock is still going down, because people are just selling the entire index.
- short_sells_poo 7y ago
  You are correct and this effect is increasing over time. More and more investment is being done on baskets of stocks as these investments became accessible through ETFs and traditional managers were not able to beat the "dumb" indices (there's nothing really dumb about them). 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.

legitster 7y ago

HBR also has published a few rebuttals of this same argument: https://hbr.org/2018/03/are-buybacks-really-shortchanging-investment https://hbr.org/2018/03/are-buybacks-really-shortchanging-in... 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.

s1artibartfast 7y ago

I would have liked to see the article address the potential advantages of stock buybacks. 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.

digitaltrees 7y ago
It’s literally impossible to exhaust R&D Opportunities. The hard part is going from research to commercialization but the is an almost unlimited amount of innovation still possible.
- airstrike 7y ago
  > It’s literally impossible to exhaust R&D Opportunities. It is not impossible, however, to exhaust R&D opportunities with an expected NPV greater than zero.
  - clairity 7y ago
    that's only limited by how you define the industry you're in. we'd have a lot more to worry about if no NPV positive opportunities existed at all (which would imply an exhaustion of relatively free raw inputs).
    - s1artibartfast 7y ago
      >that's only limited by how you define the industry you're in. 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.

throw0101a 7y ago

Stock buybacks are no different than dividends†: a form of returning capital to the owners / investors of a company. 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-still-a-non-starter/ https://www.pwlcapital.com/the-irrelevance-of-dividends-stil...

amiga_500 7y ago
So why not just issue dividends and avoid the downsides?
- jdminhbg 7y ago
  The tax code penalizes dividends by taxing recipients at the time they're paid.
  - dlp211 7y ago
    The same "penalty" applies to the capital gains realized by the sellers when the buyback happens and future sales. The only substantial difference is the ability to choose when to realize those gains by the other shareholders. It's a bad argument and buy backs should be made illegal again.
- throw0101a 7y ago
  > So why not just issue dividends and avoid the downsides? 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.
  - AznHisoka 7y ago
    But so what if it creates a taxable event? Let's put aside what is good for you in the short-term, for a second. 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.

mannykannot 7y ago

Is a company with cash on hand and low debt at risk of a leveraged buyout, leading (if it happens) to high debt and a low reserve anyway?

ogre_codes 7y ago

Anytime a company overextends itself financially, it's dangerous for the company and if lots of companies do it, the economy as a whole. Look at PG&E underinvesting in infrastructure while paying large dividends, it's the exact same problem. Companies have become micro-focused on short term returns for shareholders and lost track of longer term planning and building anti-fragilility into the company infrastructure. 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.

cornishpixels 7y ago

> In 2018 alone, even with after-tax profits at record levels because of the Republican tax cuts, buybacks by S&P 500 companies reached an astounding 68% of net income, with dividends absorbing another 41%. Uhh... well, that math doesn't check out.

ascagnel_ 7y ago
It's saying that the S&P 500 companies spent a total of 109% of their income on buybacks and dividends, intentionally and voluntarily running at a loss to increase stock prices (vs. running at a loss to grow revenues or something similar).

IanDrake 7y ago

>When companies do these buybacks, they deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn. 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.

pauljurczak 7y ago
Really? So why they are asking for a bailout now if they had not deprived themselves of needed liquidity? Have they not noticed the cyclical nature of economy? 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.
- IanDrake 7y ago
  Who took on more debt just for stock buyback that is now asking for a bailout?
  - pauljurczak 7y ago
    It's not necessarily about taking debt to buyback their stock. It is about free cash flow. Here are some facts: "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."

fallingfrog 7y ago

Here’s the thing: if a company has 1 million dollars in cash, and a 2 million dollar market cap, and they spend the cash buying back 1 million worth of stock, the total value of the company, including the cash they spent, has decreased by 1 million dollars and the stock price should therefore not change at all. 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.

exoque 7y ago
The stock price should change because the earnings per share will be higher in the future.
- fallingfrog 7y ago
  But the company is poorer by the same amount as they spent on stocks, which if the stock price is correct should reduce earnings by the same amount, canceling out to no change in the stock price.
  - pauljurczak 7y ago
    > if the stock price is correct The stock price is not correct, it is a cruel joke with very little connection to real economic activity.
    - fallingfrog 7y ago
      My point exactly
  - exoque 7y ago
    Yes, the market cap of the company is lowered by the amount it spends on the buy back, however the value per share stays the same. A year later the profit from the new year is included in the market cap which is divided by a lowet number of shares. This means the value of a single share is now higher while the market cap is the same as in the beginning. Or am i missing something?

acd 7y ago

Would it be so that stock buy backs amplify the company stock value during good times? But is the reverse true when there is a down turn in the market? Ie when there is a market down turn if a company owns its own stock it amplifies the down movement? Can someone who understands this better explain how it works?

crazygringo 7y ago

> 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. 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.

dlp211 7y ago
American airliners returned 96% of their profit as share buybacks and are now requesting a $50 billion bailout and you still want to defend borrowing money to finance buybacks, which were illegal until sometime in the 1980's. 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.
- jsanford9292 7y ago
  I am sorry to say that I agree and, to be effective, capitalism needs to work much like natural selection. 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.
  - 7y ago

OscarCunningham 7y ago

Can't companies just take on debt now, to avoid bankruptcy? Lenders should be eager to lend to them because they know that business will return to normal after the virus has passed.

mhb 7y ago

"Boeing, Which Repurchased over $100B in Stock, Downgraded to BBB, Seeks Bailout" https://www.zerohedge.com/markets/boeing-which-repurchased-over-100bn-stock-downgraded-bbb-seeks-short-term-bailout https://www.zerohedge.com/markets/boeing-which-repurchased-o...

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bitxbit 7y ago

I am shocked how many companies were so thinly spread after ‘08 and the virus exposed them. We learned absolutely nothing from 2008 (probably because the govt bailed out everyone). Does capitalism really work when we can’t even enforce true price discovery?

dgudkov 7y ago

Fascinating. Correct me if I'm getting it wrong: 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".

chris123 7y ago

They're means to transfer wealth to the executives and risk too everyone else. Simple as that.

jganetsk 7y ago

Maybe it's just profitability is dangerous for the economy. https://thenextrecession.wordpress.com/category/profitability/ https://thenextrecession.wordpress.com/category/profitabilit...

pauljurczak 7y ago

To underline huge market distorting impact of stock buyback, read this quote from Goldman Sachs Top of Mind, Issue #77 (https://www.goldmansachs.com/insights/pages/top-of-mind/buyback-realities/report.pdf https://www.goldmansachs.com/insights/pages/top-of-mind/buyb...): "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."