Stock buyback are killing the American economy

[Guest longinvestor]

Focus on the business, the numbers will follow?

 

"We don't believe in such laws as laws of large numbers," Cook said at the Goldman Sachs Technology and Internet Conference in San Francisco. "It's just sort of an old dogma, I think, that was cooked up by somebody. Steve did a lot of things for us over the years, but one of the things he ingrained in us: that putting limits on your thinking are never good. We're actually not focused on the numbers. We're focused on the things that produce the numbers." - Tim Cook

 

http://www.bloomberg.com/news/articles/2015-02-11/tim-cook-doesn-t-believe-this-made-up-math-law-will-limit-apple-s-growth?cmpid=yhoo

We're focused on the things that produce the numbers. ..

Words of wisdom.

 

Especially coming from the mouth of a steward of capital allocation.

 

I'll wager that, taken over the long term, there are very, very few capital allocators that have this real value creation mindset. Plenty of pretenders out there. And plenty of so called value investments ending up in the hands of pretenders.

[Jurgis]

Focus on the business, the numbers will follow?

 

"We don't believe in such laws as laws of large numbers," Cook said at the Goldman Sachs Technology and Internet Conference in San Francisco. "It's just sort of an old dogma, I think, that was cooked up by somebody. Steve did a lot of things for us over the years, but one of the things he ingrained in us: that putting limits on your thinking are never good. We're actually not focused on the numbers. We're focused on the things that produce the numbers." - Tim Cook

 

http://www.bloomberg.com/news/articles/2015-02-11/tim-cook-doesn-t-believe-this-made-up-math-law-will-limit-apple-s-growth?cmpid=yhoo

 

OK, I like Tim Cook. But this is facepalm worthy. "made up law"? WTH? This is stupid. Of course there are limits to which companies can grow. You cannot have more than 100% of market share. And even assuming you create new products, there's still a limit. Thinking that there isn't is pure stupidity.

[Liberty]

Focus on the business, the numbers will follow?

 

"We don't believe in such laws as laws of large numbers," Cook said at the Goldman Sachs Technology and Internet Conference in San Francisco. "It's just sort of an old dogma, I think, that was cooked up by somebody. Steve did a lot of things for us over the years, but one of the things he ingrained in us: that putting limits on your thinking are never good. We're actually not focused on the numbers. We're focused on the things that produce the numbers." - Tim Cook

 

http://www.bloomberg.com/news/articles/2015-02-11/tim-cook-doesn-t-believe-this-made-up-math-law-will-limit-apple-s-growth?cmpid=yhoo

 

OK, I like Tim Cook. But this is facepalm worthy. "made up law"? WTH? This is stupid. Of course there are limits to which companies can grow. You cannot have more than 100% of market share. And even assuming you create new products, there's still a limit. Thinking that there isn't is pure stupidity.

 

Except that's not what he was saying.

[ni-co]

Another interesting aspect of this discussion is that the hunt for yield is keeping your stock price high if you are perceived as a sustainable dividend payer by the market. You can see this effect by looking at the big oil companies that are very expensive compared to the oil price levels right now. It's as if the oil price rebound is already priced in. I don't believe that big oil investors have suddenly become value guys with 10 year time horizons like WEB or Jeremy Grantham, but it's the dividend yield that keeps the big oil stocks high.

[undervalued]

^{But the good times inevitably end, this time most likely led by the activist stampede.}

 

^{The haste in which G.M. rushed to comply to Mr. Wilson’s demands, and they and other companies shed cash rather than fight, shows that the activist tide pushing the stock buyback may have gone too far. Let’s hope that it doesn’t wash out companies and shareholders.}

 

http://www.nytimes.com/2015/03/18/business/dealbook/general-motors-stock-buyback-follows-a-worrying-trend.html

 

 

[Rabbitisrich]

c) Finally, the economic impact of a buyback has everything to do with the valuation of the stock and its future returns, while the economic value of a dividend has nothing to do with the valuation of the stock.  Management teams in aggregate have a poor record of buying back well, and bad buybacks destroy value.  Dividends can't destroy value.  When raising the payout ratio there is therefore a huge difference, which has nothing to do with tax, between a buyback policy and a dividend policy.  Opportunistic buybacks by value-oriented management teams are different, but they seldom happen.  I would argue that this is at least partly because when stock is cheap, options tend to be out of the money and debt costs may well be high, so the buyback doesn't create a huge, immediate payout for management.

 

How did the conversation devolve into another thread on buybacks vs dividends?

 

The author is simply making the statement that deploying capital into buybacks is bad for GDP growth, average American worker, and the American economy as a whole.  He is not claiming that buybacks cannot generate value for shareholders.

 

krazeenyc,

The article contains a few fundamental errors and inexplicable omissions. Maybe he has thought more deeply about why he focuses on buybacks, but he didn't share those thoughts.

 

petec,

Valuation doesn't have anything to do with the difference between buybacks and dividends. Management deserves credit or blame for adjusting the payout ratio. But once they pay out, they paid out. The money is out of their hands. Equity owners are the ones who subsequently adjust their ownership stakes. So why implicate management for shareholder decisions? Implicate management for management decisions, which is most directly represented, in this case, by their payout decisions.

 

Keep in mind that a company is not literally investing in their shares during a buyback. If the valuation shows optimism, management can just issue shares. If shares run low, management can just split shares. A buyback is a release of cash, and not a company's investment in its own shares.

[ERICOPOLY]

But today, these buybacks drain trillions of dollars of windfall profits out of the real economy and into a paper-asset bubble, inflating share prices while producing nothing of tangible value.

Where is his proof that the shareholders have done nothing with this cash that was returned to them?  They might have taken the money and invested it in nascent companies.

 

He seems to assume that it is not invested in anything at all.

 

It reminds me of a child that asked "and then what happened", only this author never even went through the first iteration of that.

 

[merkhet]

Yea, it's a pretty bad piece -- the author has no sense of second-order thinking.

[undervalued]

Despite his protestations, Mr. Fink said, “There is nothing inherently wrong with returning capital to shareholders in a measured fashion.” He added, “Nor are the demands of activists necessarily at odds with the interests of other shareholders.” But it’s when it is taken to extremes — such as it seems to be in the current marketplace — that has Mr. Fink concerned.

 

http://www.nytimes.com/2015/04/14/business/dealbook/blackrocks-chief-laurence-fink-urges-other-ceos-to-stop-being-so-nice-to-investors.html

 

I am concerned because currently market is not cheap. Usually most companies buy back when market is high and then sell shares when recession comes. By then, these activists might be gone and the long term shareholders are holding the empty bag.

[CorpRaider]

Lame.  Larry Fink wants your 401(k) account and is singing for his supper.  The capital that is returned to the actual owners of the business doesn't evaporate, for fooks sake.  It is actually just going to be allocated without the agency problems.  Management can't be bothered to land the corporate jet for an hour to file a report to the owners of the business on their plans for the owners' capital?  If you've got a nice 5 year 30% IRR project just make your case and don't crap yourself and start blowing shareholder's money on investment banks and lawyers the moment anyone other than your uncle wants a slot on the board to limit your stock options to $50 million a quarter.

[undervalued]

“I think it’s nuts,” he said. “If you’re running a business for the long term, the last thing you should be doing is borrowing money to buy back stock.” - Stan Druckenmiller

 

http://finance.yahoo.com/news/stan-druckenmiller-sees-massive-problem-130107781.html

 

[ourkid8]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

Tks,

S

 

“I think it’s nuts,” he said. “If you’re running a business for the long term, the last thing you should be doing is borrowing money to buy back stock.” - Stan Druckenmiller

 

http://finance.yahoo.com/news/stan-druckenmiller-sees-massive-problem-130107781.html

[Jurgis]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

[AzCactus]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years. 

[randomep]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years.

 

Can someone here give example(s) of companies with low returns borrowing at high rates to buyback shares?

[mvalue]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years.

 

Can someone here give example(s) of companies with low returns borrowing at high rates to buyback shares?

 

Of course not - any company paying nominally high interest rates in this environment is distressed and not in a position to use those funds for buybacks.

 

The question is how the prices being paid for repurchases will look a few years out. If you borrow at 2% and buy stock at trading at 20x it's ostensibly brilliant and highly accretive. It doesn't mean it will prove so later - it might or might not. Cheap funding is a boon if the prices being paid are good. If cheap funding just drives prices higher, it might not be such a blessing. On average are we clearly at least into a grey area if not worse.

[randomep]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years.

 

Can someone here give example(s) of companies with low returns borrowing at high rates to buyback shares?

 

Of course not - any company paying nominally high interest rates in this environment is distressed and not in a position to use those funds for buybacks.

 

The question is how the prices being paid for repurchases will look a few years out. If you borrow at 2% and buy stock at trading at 20x it's ostensibly brilliant and highly accretive. It doesn't mean it will prove so later - it might or might not. Cheap funding is a boon if the prices being paid are good. If cheap funding just drives prices higher, it might not be such a blessing. On average are we clearly at least into a grey area if not worse.

 

Ok let me rephrase.

 

Can someone give example(s) of companies where

 

1/PE - i  is dangerously small.

 

where i is the borrowing interest rate.

 

In other words, what companies will be the first to blow up in 2-3 years when it does happens as the OP predicted.

 

 

[mvalue]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years.

 

Can someone here give example(s) of companies with low returns borrowing at high rates to buyback shares?

 

Of course not - any company paying nominally high interest rates in this environment is distressed and not in a position to use those funds for buybacks.

 

The question is how the prices being paid for repurchases will look a few years out. If you borrow at 2% and buy stock at trading at 20x it's ostensibly brilliant and highly accretive. It doesn't mean it will prove so later - it might or might not. Cheap funding is a boon if the prices being paid are good. If cheap funding just drives prices higher, it might not be such a blessing. On average are we clearly at least into a grey area if not worse.

 

Ok let me rephrase.

 

Can someone give example(s) of companies where

 

1/PE - i  is dangerously small.

 

where i is the borrowing interest rate.

 

In other words, what companies will be the first to blow up in 2-3 years when it does happens as the OP predicted.

 

I can't speak to companies going bust, only to the risk of aggressive/poor capital allocation going on. I don't think the spread between borrowing rates and 1/PE is going to be a very good way to identify those companies. It is more likely to me that cases where the spread looks most superficially appealing might be the most prone to overdo and overpay.

 

Think of companies buying stock today at 20x on what might prove to be cyclically high earnings. Imagine in 2019-2020 that debt has to be rolled over at much higher rates, the stock is at 15x, and earnings growth over the full period has been modest or zilch.

[physdude]

I do not think a lot of thought was used before he made that comment.  Look at Philip Morris international, they can borrow at 2-4% and retire shares with almost a 5% yield.  - Absolute no brainer!

 

I doubt he'd disagree with you that there are exceptions.

 

I think his point is that majority of companies are borrowing money to buy back expensive shares. When downturn comes they might be hit with double whammy: stock drops but they don't have money to buy back cheap shares and they have to pay interest on debt.

 

+1 Clearly some companies maybe borrowing prudently.  By and large however, these companies are acting irresponsibly and will face consequences down the road.  My guess is 2-3 years.

 

Can someone here give example(s) of companies with low returns borrowing at high rates to buyback shares?

 

How about Arcelor Mittal (MT) in 2007 and 2008? They were buying back shares at close to $100/shr on very high earnings which turned out to be highly cyclical. They then had to issue convertible debt with a strike of just around 25 when the financial crisis hit. A more recent example is ASPS which issued debt to buy back shares at around $100/shr. This actually threatened the viability of their business after the NYDFS signed an onerous agreement with  Ocwen. Borrowing to buy back shares doesn't seem a good idea to me unless there is a substantial moat and undervaluation but using FCF to do so can be a very good idea (like STX in the recent past).