If you don’t already have one, I’d recommend starting a hate list. Obviously you’re not going to do anything to anyone on the list, but it’s fun to crack out when someone pisses you off, as you menacingly announce they’ve been added to “the list.” Who’s on my list? I’m sorry, but if I told you then I’d have to put you all on the list. And it’s a pretty long list already.
Let me get you started on your own list. One thing you should add, assuming you’re an investor in individual stocks, is share buybacks. FEEL THE HATE. Embrace the hate. Go ahead, yell really loudly. People will only judge you for a little while, and then some nice men will come and take you to a room with soft walls. It’ll be nice.
Anyhoo, let’s back up. What exactly is a share buyback? Why should you care? And what’s that weird growth around my testicles? Whoa Sparky, that last question was a little TMI, don’t cha think?
A share buyback is when a company takes excess cash and buys back their shares in the open market. The board of directors will set a price range, a total amount of money and a maximum number of shares they want to buy back, and they’ll have at it. They’ll hire a broker to do it, and they’ll typically just focus on buying large lots of shares, since buying up small lots is a pretty effective way to increase your own share price.
An example: Nelson Co., maker of dildos and inflatable ladies, has 100,000 shares at $10 per share. Because the creepy sex toy business is doing well, he’s got enough cash kicking around to buy back 5% of his shares. So he hires a guy to go into the market and do just that. When it’s over, Nelson Co. only has 95,000 shares left outstanding. Assuming all things stay the same, each remaining share will be worth 5% more. Pretty simple, right?
On the surface, this seems good. A company is giving money back to shareholders, albeit indirectly. Hell, it’s almost as good as a dividend, and we all know how badly you guys get excited over those. And hey, if a company buys back 5% of their outstanding shares every year, eventually there will be very few shares left outstanding.
This seems pretty great, right? Why am I opposed to it? Am I some damn angry Canadian with a chip on my shoulder because I don’t get laid very often, like half the PF blog-o-net wants to believe? DON’T ANSWER THAT. I HAVE FEELINGS.
Nah, here’s the real answer. It’s because companies are generally pretty bad at buying back their own shares.
Generally, company balance sheets tend to look pretty good after the stock has had a few years of continued success. Apple has been a terrific investment over the past decade, unless you happened to buy over the last 3 months or so. As the company continued to perform, earnings continued to sit on the balance sheet. Eventually, the company starts to run out of stuff to buy or companies to acquire. So they do one of two things – they increase the dividend or start to buy back shares.
Sticking with our Apple example, the company decided to buy back shares and start paying a dividend, back in March of this year. The share buyback wasn’t scheduled to begin until now, so the market had plenty of time to get excited about it. And the market has been super excited about it, as the close to $100 loss per share can attest.
Wait, what? Shouldn’t the stock have gone up?
Sure, in theory. But the market doesn’t exist in a vacuum. Apple’s shares have been beaten up lately thanks to a myriad of factors, including sluggish new device sales and the popularity of competing products. For the first time in years, there are some serious question marks surrounding the future of the gadget maker.
So to summarize, we have a company trading at close to an all time high with serious question marks. Is this really the best time for them to start buying back shares?
Almost universally, companies are bad at this. Research in Motion bought back $2.9B worth of shares in 2010, at an average price approximately 5 times where the stock trades now. Cerner Corporation just authorized $170M of share buybacks, even though the shares are trading near an all time high. It’s the same thing with FIS, CLGX, and probably quite a few more than I’m too lazy to look up. Considering the public’s thirst for yield, maybe taking the cash and paying out a dividend would be more effective.
There’s another ulterior motive that management will sometimes try to hide with share buybacks, and that’s the affect of their options.
If management knows that their options will increase the share count by 5%, often they’ll convince the board of directors to authorize a corresponding share buyback. Companies with increasing share counts typically aren’t too popular, since investors are scared of their existing shares being diluted away. If the company can keep the share count fairly constant, it’ll only help existing management. So yes, sometimes management of a publicly trading company will act in their own selfish interests. GASP.
I’m not trying to paint all share buybacks with the same brush. Some are good, others aren’t so good. It’s up to each investor to do their own research (HOW DARE I SUGGEST YOU ACTUALLY WORK AT INVESTING) and to see whether they’re comfortable with the buyback. If you think Apple is a screaming buy at $500 per share, then you’d obviously think the company’s share buyback is a good idea.
Sometimes share buybacks are best. Sometimes dividends are best. And sometimes, companies should just hoard cash because good acquisitions come along. It’s easy to identify bad stock buybacks using the benefit of hindsight. The tricky part is figuring it out now. Hopefully this guide helps.