Power of Corporate Stock Buybacks– Hit High of $1 Trillion in 2015: Creates Real Value, Just Another Wall Street Scam…

Beware of corporations bearing special gifts– some corporations love stock buybacks… According to Jeff Reeves; stock buybacks (or stock repurchase) are clever accounting trick… but many experts are skeptical as to how much stock (share) buybacks actually help publicly traded companies, or if they even help at all…

According to Warren Buffett; there is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds– cash + sensible borrowing capacity– beyond the near-term needs of the business. Second, the company finds its stock selling in the market below its intrinsic value, conservatively calculated…

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According to Bloomberg; companies have been increasing their buybacks and dividends for years, e.g.; total payouts from S&P 500 companies surged 84% in the past decade to $934 billion in 2014– roughly 95% of all corporate earnings! Hence, in many cases you are left to read between the lines and try to figure-out whether companies are just blindly participating in the buyback frenzy, or are they actually being thoughtful about providing value to their shareholders…

According to Fortuna Advisers; over past five years, 216 companies in the S&P 500 got more of an increase in their ‘earning per share’ (EPS) from share buybacks than from growing their businesses… Last year, companies in S&P 500 spent $500 billion on stock buybacks– the most since the record of $589 billion in 2007– and these companies have spent a staggering $1.7 trillion since 2008…

Some experts say it’s one reason the stock markets have soared despite weak economy… Stock buybacks have magically transformed what would have been an 80% increase in the S&P 500, from the 2009 lows, to 178% increase… According to Gregory Milano; it’s game playing– a legitimate, legal form of manufacturing earnings growth… a lot of people focus on earnings per share growth, but they don’t adequately distinguish the quality of the earnings…

Stock buybacks can mask other problems a company may have, which also explains their rising popularity. But because the situation varies from company to company, it’s up to investors to figure out what’s really going on… According to Howard Silverblatt; a price-weighted index like the Dow Jones Industrial average will be affected more by share buybacks for its 30 component companies, whereas the value of a market capitalization-weighted index like the S&P 500 won’t be impacted to anywhere near the same degree… given the difference in how the indices are constructed…

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In the article Stock Buybacks– Pros and Cons by Aaron Smith writes: The motives for a stock buyback are wide-ranging, and the precise motives for buying back the stock are often never known by the common investor. Stock buybacks have typically been seen in a positive light, but over the last few years more and more people have begun to question buybacks as a strategy to create value for shareholders… Many are asking: Is it really the best way a company can spend their money? Here are a few ‘pros’ and ‘cons’:

Stock Buyback ‘Pros’:

  • A company that buys back its own stock usually believes the stock is undervalued and believes it’s a good buy. This is obviously a good sign for shareholders because the company is basically betting on their continued success…
  • Stock buybacks create a very nice price support level for investors. This is especially true in recessionary periods or bear market periods. A stock that has a massive stock repurchase program going on will have that extra price support that can serve as a safety net for investors in the stock…
  • Buying back stock means less outstanding shares, which means higher earnings per share number, if all other things stay equal. A higher ‘earning per share’ (EPS) is always important in the market…

Stock Buyback ‘Cons’:

  • Serve as an easy cover-up for poor financial ratios at the company. A company can buy their own shares and create an artificial lift in their financial ratios which makes market observers believe things are improving, even if they are not…
  • Allow the company insiders to take advantage of stock option programs while not diluting the overall EPS that is reported to the market…
  • Can create a quick and often artificial jump in the price of a stock, and insiders then quickly sell at a higher price while individual investors tend to be late buying into the stock and buy-in at high price levels. Long-term prices have not been directly correlated to share repurchase, but in short-term stocks often have a big bounce…

In the article Bad Buyback, Bad! by Motley writes: The math behind buybacks is simple: By buying back their own shares, companies reduce the number of shares the corporate pie is divided into, leaving existing shareholders with a larger slice of everything from net assets to earnings per share. On top of this, fewer shares available for trading reduces supply on the open market and might help give share prices a boost…

In essence, when a company buys back its shares, it moves capital from one part of the balance sheet to another… hence, every share bought back by a company comes with a corresponding drop in cash on the balance sheet. When times are good and cash is flowing, a buyback strategy seems reasonable but when money gets tight, then that same company may be forced to issue shares en-masse to regain the needed liquidity…

Hence, always look a little closer, e.g.; sometimes it’s a way to clean-up the damage done by issuing stock options given to employees, management… or other issues. However, when companies have excess cash and their share prices undergo a beating, buybacks can be a great tax-free way to reward shareholders…

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In the article Importance of Dividends and Buybacks by Jeremy Schwartz writes: Firms have engaged in increased share buybacks activity over recent years. While theoretically buybacks function in a very similar way as dividends for returning cash to shareholders, there are some key differences between dividends and buybacks. The key differences include:

1) Distribution of Cash:

  • Dividends: All shareholders of a firm receive dividends when they are distributed…
  • Buybacks: A select group of investors sells shares back to the company either in the open market or during a period in which investors receive the option to sell all or a portion of their shares back to the company within a certain time frame known as a ‘tender offer’ period. Only those who elect to sell their shares back to the company during the buyback program receive cash, and there is risk that if investors defer selling to the future that stock prices will move lower…

2) Timing of Benefit:

  • Dividends: The benefit, or the cash received, from dividends occurs at the time the dividends are paid, and therefore reflect a historical measure…
  • Buybacks: The benefit from share buybacks– a reduction in shares outstanding– is a benefit that applies to future distributions. Even though only a portion of shareholders sell their shares back to the company, the reduction in shares benefits all the remaining shareholders; the total future cash distributions by the firm are divided in the future among a smaller shareholder base. The concomitant rise in share price associated with the reduction in float benefits all investors on paper at the time of the buyback, and at the time of some future sale in cash terms…

3) Transparency:

  • Dividends: Once firms state their intention to pay a regular dividend, the vast majority of companies follow through with that commitment unless there is an extraordinary downturn in business prospects…
  • Buybacks: Firms announce plans to buy back stock that often are not carried through to execution… In pure finance theory, when it comes to weighing the ‘pros’ and ‘cons’ of the features of dividends and buybacks, share buybacks are often a preferred method for returning cash to shareholders… The key point to realize is that firms must account for both ways when gauging the historical relative valuation levels of the market…

Expert opinions differ over the ‘pros’ and ‘cons’ of share buy-backs, including; whether they are a better means of distributing surplus cash than paying a bigger dividend, and whether they distort executive-bonus schemes by artificially boosting the share price and raising earnings per share (same earnings, fewer outstanding shares)… There are certainly two sides to the argument of what a stock buyback means for a stock and the individual shareholder. The prevailing thought on the street has generally been that it’s a positive when a company decides to invest in itself, but over the last few years there have been more questions raised as to the motives for share repurchase programs…

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Simply put there is no right or wrong answer as to whether a stock buyback is a positive or negative for a stock– the true answer depends upon the individual case… Although many executives consider the buyback boom a no-brainer… Trouble is, stock buybacks are only a boon in theory. In practice, buybacks frequently don’t do much for shareholders, and there is very little corporate accountants can do to change the state of the underlying business…

Perhaps stock buybacks may lessen a company’s pain during a rough patch, or creates a modest tailwind when times are good… Hence, whether you consider them good or bad; the fact is– buybacks do not substantially change anything in a company…