
Why I Don't Like Stock Buybacks - wheels
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yummyfajitas
_But I don't view that stock buyback as successful.[...]But we let the cash
sit in the bank and worse we gave a lot of it back to investors in a manner
that did not do much for the company._

Cash for investors? But doing nothing for the company? That's a good thing and
more companies should do this.

The sole purpose of the company is [1] to _increase shareholder value_. If
reinvesting in the company would bring above-market returns, then it's a good
idea to do. If not, corporate leadership should increase shareholder value
with cash rather than building an empire with other people's money.

[1] I ignore nonprofits and corporations with special clauses in their
charter.

~~~
dhimes
_The sole purpose of the company is ... to increase shareholder value_

The root of all evil, right there.

I prefer companies whose sole purpose is to act as an engine of change for a
better world. Even Drucker's (?) "sole purpose of a company is to get and
retain customers" is better.

My real problem with your quote (from Friedman is it?) is that when a
majority, or even a vocal and persuasive minority, or people adopt that
attitude it throws out a lot of the social constraints in place to keep people
running the companies from doing things that harm us as a society. That is,
"he was just acting in his own best interest" can be used to justify many acts
that are selfish and short-sighted, because there are no social consequences
of this. Even people of high personal moral standards are willing to give a
pass to evil deeds because "he did what he had to do."

I disagree.

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pkaler
You are conflating the words value and revenue. Change is a type of value.
Time is a type of value. Happiness is a type of value.

~~~
dhimes
You are absolutely right. I was referring specifically to financial value. I
bet I'm not the only one who makes this unconscious substitution, but you are
nevertheless correct.

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philk
I think he's missing the point. When a stock is trading below its tangible
book value each share of stock bought back delivers increased value per share
to the remaining stockholders.

The only reason _not_ to buy back shares if they're trading below tangible
book value [1] is because you have investments available that will yield
greater returns, or do not have sufficient cash to do so.

[1] Factoring in a margin of safety, of course.

~~~
meterplech
He realizes your point- he remarks "We just gave back a lot of cash to the
investors."

His point is that companies that can't find better ways to use capital than a
buy back aren't innovative enough to succeed in the long term

~~~
philk
No he doesn't. From the article:

 _Stock buybacks are very popular with some investors as a way for a company
to transfer value from the company back to the shareholders. It is like a
dividend, except it is taxed as a capital gain, not ordinary income._

He's approaching it from the opposite direction; ie returning value to
investors who are selling their stock. But if the company is truly worth more
per share, in terms of tangible book value, than the price the shares are
trading at then anyone who is selling up is getting a bad deal. These people
aren't getting value. It's the people who retain their stock who are getting
value because they're managing to buy slices of a company worth $(X+Y) for
only $X.

A simplified example:

FictionCorp has $200 million in the bank and 100 million shares outstanding.
For some reason, the shares are trading at $1, despite the $2/share sitting in
the bank.

If FictionCorp manages to go and buy back half its stock at $1/share, it now
has $150 million in the bank but only 50 million outstanding shares. Each
share now represents $3 worth of cash in FictionCorp's bank account.

Hence, the remaining stockholders are better off because they've managed to
buy a larger portion of FictionCorp at a discount to its actual value.

~~~
yummyfajitas
It's highly unlikely that FictionCorp will manage to buy half it's stock
without moving the markets. Most shareholders who sell will get significantly
more than $1/share.

~~~
philk
It's a simplified example. Of course it will move the markets, and buying back
half the outstanding stock is highly unlikely in any case. I just used those
figures to make the math simple.

~~~
yummyfajitas
Lets assume you are correct. In that case, you should do the following:

Go buy shares at $1.01 during the buyback (people will sell to you rather than
FictionCorp, since you are the best bidder), then sell them at $3.00 after the
buyback is finished. This is a moneymaking opportunity whenever the share
price is below $2.00.

Come back when you are rich and I'll believe you found an inefficiency in the
market. Until then, I think you are wrong.

~~~
jakarta
Look, I understand that this wont persuade you. From other threads, I know you
are a hardcore proponent of EMH. But someone else might find this insightful:

Buybacks work in theory, but they depepnd on a lot of factors.

Essentially what you are trying to do is shrink the existing share count, so
that EPS goes up which presumably drives your share price up in the longer
term.

E.g.:

$10 in net income / 10 shares = $1 EPS. Lets say right now you are trading at
a 6x multiple, the market is nervous about your prospects. You think your
shares are undervalued and that you are probably worth 10x (perhaps your
industry average).

So you buyback 20% of your shares, existing share count decreases from 10 to
8. EPS goes up to $1.25 per share.

But, one of the uncertainties behind a buyback is the fact that you never know
when or how much management will actually buyback. They will sometimes
announce a plan that would buyback 20% of shares, but only do that over maybe
10 years. Thats why your bit about timing the buyback just doesn't work.

Let's say somehow you do manage to buyback the 20% in just one year (the
market hates your company). So with an EPS of $1.25, if the market keeps
giving you that 6x multiple, in theory your shares should be worth at least
$7.50, not the $6 before. Moreover, if the buyback signals enough confidence
in the company, maybe the market will realize it and you will return to the
10x multiple you had before, so your shares go to $12.50

But see nobody can time when the market works or when the market will catch on
to the value of your company. Benjamin Graham said that is one of the great
mysteries of the stock market when he testified before congress.

It is during that lag time when the share price does not move that investor
confidence can waiver and maybe they will sell -- ultimately not realizing the
value that eventually comes from the buyback and reduced share count.

~~~
yummyfajitas
_From other threads, I know you are a hardcore proponent of EMH._

I don't know where you get that idea. I work for a hedge fund, which would be
really dumb if I believed markets were efficient. That would mean my expected
bonus is $0 [1].

When a rich person tells me "markets were inefficient, and now I'm rich", I
often believe them. When a person tells me "look, a whole bunch of idiots are
throwing their money away, but I'm not going to take it off their hands", I'm
a little skeptical. And when someone says "look, the markets are inefficient
_in a manner that is extremely obvious and easy to exploit_ ", I'm also a bit
skeptical, since most such inefficiencies have already been arbed away.

Lastly, my trading strategy doesn't require the buyback to complete. All it
requires is that philk's claim actually occurs: that the buyback transfers
money from sellers to shareholders. Using his numbers and my proposed buy
price of $1.01, the moment the buyback has transferred at least $0.02/share
from sellers to shareholders, the strategy has become profitable.

[1] Not strictly true, since a bonus behaves like a call option on profits,
but you get the picture.

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byrneseyeview
_[A]fter the market broke in early 2000, the stock was trading below its cash
value... I don't remember the exact details of the buyback at TheStreet.com
but we started buying the stock and it kept going down. We kept buying it. But
we were losing money on each buyback because we were overpaying for our own
stock as it kept going down._

If you're buying a dollar bill for 90 cents, and someone offers you a dollar
bill for 80 cents, you didn't lose money.

I disagree with this post. If TSCM was trading at less than net cash, a
buyback meant that they were _getting paid to own more of it_. That's an
incredible deal. Also, they did something that would gave the business a
temporarily negative market value (i.e. cash plus business is worth less than
cash alone)--and they thus should have invested more cash in the business?
That doesn't make sense.

Either the stock market was right, TSCM was worth liquidation value, and the
buyback was a way to gradually liquidate the company... or the market was
wrong, the TSCM business was worth more than the stock's market price, and
buying back the stock was a great move.

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Nwallins
I don't understand this point:

> _I don't remember the exact details of the buyback at TheStreet.com but we
> started buying the stock and it kept going down. We kept buying it. But we
> were losing money on each buyback because we were overpaying for our own
> stock as it kept going down._

It seems to me that if your stock is trading at under book value, then you
would be _underpaying_ if you are buying it. Especially if it keeps going
down.

Isn't the idea that the stock is undervalued? Why not buy low now and even
consider selling high at a later date?

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meric
Companies perform stock buy backs when they don't have any ideas in how to
invest their cash. A recent example is an Australian company called "CSL". A
year or so ago it held a massive share raising and was proposing to use the
cash to buy out a US pharmaceutical firm. The US regulator thought it would
give CSL too much market power and stopped the deal from happening. What CSL
did was initiate a stock buy back to return the cash to investors. Link:
[http://www.theaustralian.com.au/business/wealth/upside-
for-c...](http://www.theaustralian.com.au/business/wealth/upside-for-csl-
investors-share-buyback/story-e6frgacx-1225715690408)

It's not necessarily not good.

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skybrian
If you assume no more profits and a fixed cost to winding the company down
(you can't actually get all the cash back) then buying back stack reduces the
cash to required expenses ratio, so it would make sense for the stock price to
go down. At the point where cash equals the remaining expenses then the stock
is worth zero. But this shouldn't happen for a profitable company, even if
they are "out of ideas".

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adamilardi
Dividends are much better. Once the market speaks a formerly mighty stock can
drop very quickly. I'd rather have the cash now then a slow reduction in
supply. After the "great recession crash" we saw how demand can change and
even with less supply see huge drops in stock price.

~~~
yummyfajitas
If you prefer dividends, sell shares back to the company in proportion the
share buyback. It's mathematically equivalent to dividends (you own the same
fraction of the company before and after), but you pay less tax.

~~~
tocomment
Any references on that? It sounds possible, but I thought I had heard of cases
of stock buybacks not increasing the share price.

I guess obviously if a company does a buyback but the stock goes down for
unrelated reasons then you're really not gaining anything.

~~~
yummyfajitas
Simple arithmetic. If you hold 100 shares of 100,000 outstanding shares, you
own 0.1% of the company. If they buy back 5000 shares and you sell 5 shares,
you still own 95 shares of 95,000 outstanding shares (0.1% of the company) +
cash.

That's exactly what a dividend would do.

Silverlake is correct to point out that this doesn't apply to small investors,
however.

~~~
adamilardi
95,000 is not correct those 5000 shares don't disappear. They are still
outstanding. The only way I know to decrease shares is a reverse split or
increase them via an offering

~~~
adamilardi
Thanks for responding. can you point to me some articles explaining more about
retired shares?

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damoncali
Fred is just wrong on this. Companies exist to enrich the shareholders. A
buyback is very much like a dividend, and should be viewed similarly. Is he
saying that companies shouldn't pay dividends? That's insane. A company with
too much cash is wasting it's investors' money.

~~~
fredwilson
Damon

I like dividends for mature cash flowing businesses who cannot find a good use
of their cash

Fred

~~~
d2viant
Yes, but you're paying a hefty price to get your money that way -- mainly the
double taxation on dividends. Stock buybacks can be a more efficient way of
returning that cash to shareholders.

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Sukotto
Personally, I wish they would spend that money on making their email client
display html well. It sucks for emailing tabular data to business owners.

They could also greatly improve their web browser. Apple's devices totally eat
RIM's lunch when it comes to browsing.

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T_S_
"I didn't understand what was going on. We had more cash than it would take to
buy back every share in the company and yet the stock kept going down."

Obvious exaggeration. How many companies have more cash than market cap? Only
ones that owe the money to someone else and cannot use it to buy back their
stock. That made me question the whole article.

~~~
jakarta
Screening for negative enterprise value (Market Cap + Debt - Cash) is pretty
popular. There aren't a whole lot of stocks that have it, but you can usually
find a handful based in the US.

They are sort of an inefficiency. In one sense, you are buying a stock for
less than the cash on balance sheet. You could come in and liquidate it,
making a profit.

On the other side, sometimes stocks trade at negative EV because management is
doing some terrible things. Maybe they are burning through cash at an alarming
rate. Sometimes an activist will come in and stop the cash burn.

I would also like to add that you can find negative EV stocks abroad more
readily. There was a period when these opportunities existed in Korea (I think
around 2004). It was pretty amazing if you were an investor.

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joubert
It would be interesting to see the writer debate share buybacks with Buffet.

