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truthisntstupid (92.79)

Disappearing Buybacks?

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December 26, 2009 – Comments (11) | RELATED TICKERS: PEP

    It's a tricky world out there.  There always seems to be new things to have to be on our guard against.  They don't always have to be new,either...

Sometimes they're more established, even having become something "everybody knows",  part of the conventional wisdom that many people just accept without further investigation.  So some people may never make an effort to uncover the truth. 

The truth about share buybacks is that they may not be such a wonderful deal for shareholders.  I want to cast some doubt.  I want to poke some holes in what many people believe is a great way for a company to add value to their stock.

They tell us that the earnings pie is cut into fewer pieces after a buyback, which raises earnings per share and adds value..  They tell us that share buybacks are better than dividends because of the double taxation. 

Sure, just throw the money away, that way I won't have to pay any taxes on it. 

Things are not always what they seem.  I won't just tell you why I don't like share buybacks.  I will also give you some numbers.   Numbers that you can also check against your own companies.  You might be surprised what you may find out.

First, my rant.

I believe share buybacks are usually complex and expensive.   Of course they're expensive!  Companies repurchase shares during times that they're making the most money, when the economy's doing well.  These just also happen to be the times that share prices are high and very likely selling at a premium.  

I believe share buybacks are devious, and of negligible value to shareholders.  Too many end up being reissued to company management as excessive compensation.  Shares reissued to executives and others who have options and stock grants in their compensation package are not a return of capital to shareholders.  They are not removed from the float.

Do companies that engage in share buybacks outperform those that don't?  Is there a noticeable effect on EPS or FCF?   Or is the convoluted path they take from the market through the treasury stock account to the stock options/grants for senior executives and board members simply a purposely complex trail meant to disguise share dilution due to executive over-compensation?

I have some shares in PEP.  Between 2003 and 2007 PEP spent $10,298B on share buybacks.  Share count was reduced from 1.705B in 2003 to 1.605B in 2007.  So did $10.298B buy only 100M shares?  The numbers say this is $102.98 a share.  The record says that PEP never approached $100 a share during that time frame.  Did I get value out of that share repurchase?  If I did, I'm sure it was mighty small and the shares that weren't given away were still bought at a premium to their value.  I doubt very much if value was created.  More likely it was destroyed. 

Of course, sometimes shares are hoarded in the treasury stock account and used for acquisitions, which often aren't that great a use of the company's capital either.  Organic growth from within is usually much more positive for return on equity than trying to buy it.   They never get a good deal on acquisitions, do they?  That's why there has to be an accounting for the  premium paid in the form of goodwill on the balance sheet.  So then you have shares that were overpaid for being used to enter into a transaction where the company also has to pay a premium for the value it's getting.  How much value was created there?

All that being said, companies that generate far more cash than they can realistically reinvest in their core business can't just send all the excess out as dividends.  I know that.   By paying some out as dividends and using some to buy back shares, they have more choices to manage their way through hard times like this last year.  Many never did cut their dividends, but they could choose to halt their share buyback plans without any real repercussions.

Companies do have to do something with the excess cash they generate.  A company that has a return on equity of 25% can't realistically expect to grow at a 25% rate for very long (or at all, if it's a mature company and already very large).    But I feel the conventional wisdom we're all fed about share buybacks is for the most part nonsense.

And in any comparison of the two I'd rather have cash any day than have my company waste money for me.  I can do that myself.  A larger piece of the earnings pie?  Please.  They can play earnings like a guitar.  They can't do that with dividends.

Check some of your own holdings.  See if you, too, had share buybacks where the math doesn't add up.  I bet you do.....

 

 

11 Comments – Post Your Own

#1) On December 26, 2009 at 10:29 PM, HarryCaraysGhost (99.71) wrote:

HOLY COW!!!

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#2) On December 26, 2009 at 10:41 PM, truthisntstupid (92.79) wrote:

Hi, msftgev

Hey, I checked out your portfolio.  I bet you're gonna make some money.  I think you're going for the real long-term.  Is that your plan?

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#3) On December 26, 2009 at 11:29 PM, HarryCaraysGhost (99.71) wrote:

Hi truthisntstupid

Yes that is my plan. As I get closer to retirement I'll need to focus on boring stuff like bonds, laddering Cds.

But I would love to have a portfolio that paid my expenses though Dividends and Interest,and never have to touch the principle.

I've got 20 yrs to work on it so now I'm just trying to gain capital

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#4) On December 26, 2009 at 11:35 PM, checklist34 (99.73) wrote:

i have long held this sneaking suspicion that share buybacks are far inferior ways of delivering gains back to shareholders than dividends.

dividends > buybacks

many shareholders will use the dividends to buy more shares anyway (dividend reinvestment) and this will reduce the amount of "available" shares anyway, so in that way divi's have some of the same effect.

i don't have any statistics to demonstrate this, but i get the strong feeling that the same company that performed the same ... but in one case they bought back shares and in one case they paid dividends (same $$$ either way) the overall return to shareholders would be better for the dividend paying company.

csco, dell, and these other monstrous multi billion dollar buyback programs just aren't getting it done for shareholders... 

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#5) On December 26, 2009 at 11:37 PM, truthisntstupid (92.79) wrote:

msftgev

Good luck, pal!   That's a really forward-looking portfolio!  I hope it does well for you, and I bet it will. 

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#6) On December 27, 2009 at 12:08 AM, truthisntstupid (92.79) wrote:

checklist

I agree 100%.   I've been suspicious of buybacks for a long time.  Shareholders don't get a larger piece of the company when its all said and done.  A lot of companies don't expense these stock options/stock grants, either, so that their effect on reported earnings can clearly be seen.  In The Warren Buffet Way, Robert G hagstrom tells us that Buffet cautions us to watch how they are accounted for on a company's balance sheet.He believes they should be expensed so that shareholders can see how they affect repoted earnings.  Apparently, most of the time they aren't.

  Hagstrom writes, "To a comp committee, however, the difference may seem unimportant - particularly if, as has been the case at many companies, neither grant will have any effect on reported earnings.  Under these conditions, the negotiation often has a 'play money' quality."   He goes on to write that Buffet's strong feelings on this can be seen in the high praise he gave CEO Jeff Bezos when Amazon announced in 2003 that it would start expensing stock options.  "Buffet wrote to Jeff Bezos and told him his decision would be "recognized and remembered."  A week later, Buffet bought $98.3M of Amazon's high-yield bonds."

By the way...The Warren Buffet Way is a pretty good book.

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#7) On December 27, 2009 at 1:02 PM, Teacherman1 (47.48) wrote:

Good post Truth.

I also agree that dividends are better than buybacks, unless for some reason shares are being beaten down for no good reason. The problem is that they seldom buy enough to do any good.

If the buybacks are used for a acquisitions that are well thought out and increase the overall value of the company, then I would go for that.

Don't remember if you hold many, if any, limited partnerships, but they can be a good source of "dividends". Especially if the Partnership is related to a "parent" company that has a large position in them, and has incentive to make sure they continue to pay.

JMO and worth exactly what I am charging for it.

Hope you had a Merry Christmas. 

msftgev- wow, that's quite a change in your portfolio. Am adding you to my favorites to keep an eye on what you are doing. 

 

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#8) On December 27, 2009 at 1:38 PM, truthisntstupid (92.79) wrote:

Teacherman

Thanks for the suggestion. I've been lokking at BPL, which I have a DSPP prospectus for.  Anyone who takes a close look will find that even if they do buy back enough shares to do any good, a large part of the effect of the buyback gets offset by the stock options/grants issued to executives and board members and never shows up on any statements.  One has only to run the numbers to find out.

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#9) On December 27, 2009 at 4:47 PM, truthisntstupid (92.79) wrote:

I think I'm done blogging.  When I put thought into something that I believe should be significant to investors on an investing website and watch it get pushed off the page by hypnotoads with nothing to say and political blogs with titles totally unrelated to their content (where's the part about Greenspan)  I do believe I have much better things to do.

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#10) On December 27, 2009 at 5:37 PM, HarryCaraysGhost (99.71) wrote:

Truth, thats a good point about blogging here, but I always hit the more icon. If I see your or someone elses Caps name that I want to read then I click.

Thanks

Msftgev. 

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#11) On October 27, 2011 at 9:25 PM, HarryCaraysGhost (99.71) wrote:

Holy Cow!

In hindsight I wish I had'nt closed all the picks that I made during that time. Tried just having my RL picks and that got really boring really fast.

I have a watchlist on scottrade that I labeled cheap socks created in oct 2008 and the returns are insane. Wish I were a millionare back then because I'd be a billionare now :)

The artist formerly known as msftgev.

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