Share Buybacks At Any Price

[Parsad]

I never understood this behavior and I still don't.  I remember the general counsel for ITEX telling me that there are several studies that show share buybacks don't actually benefit shareholders signficantly in the long-run, and then I had to explain that was because most corporations paid any price for their shares, rather than only buying them back when they were well under intrinsic value.  This CNBC article is the same thing. 

 

http://www.cnbc.com/id/45400632

 

Share buybacks historically have not worked because CEO's implement them automatically, so that their compensation bonus targets are hit based on earnings per share.  If they can't think of anything to do with the cash, and don't want to face hostile proxies, they simply pay dividends which are inefficient or implement automatic stock buybacks.  But there is a big difference between the prices corporations were paying in 2007 to buy back their stock and what they are buying them back at today.  A good example was Teledyne, or even when Prem bought back 10% of Fairfax's stock in the early 1990's.  You buy it back only if it is dirt cheap and fully accretive.  Cheers! 

[Uccmal]

What's new under the sun? 

 

Observationally, very few managers do buybacks well.  One current example of a good buybacks is Bestbuy.  Generally though I think managers have an inflated sense of their own abilities.

 

This made me think of Potash Corp.  The insiders were all buying stock right at the commodities peak.  The stock price dropped shortly after and has not recovered for 3 years. 

 

Alot of companies report buybacks in their headline but don't report share dilution with the same vigor.  It ends up netting out to zero change in the end.  Alot of BS.

[ERICOPOLY]

I am happy to be alone in thinking that buybacks instead of dividends are just fine -- at any price.  I guess that's because I see a lot of value in the dividend->capital_gain laundering pass-through.

 

And I'm happy if a corporate chieftain wants to pay me too much for my shares  ;D

[biaggio]

I am happy to be alone in thinking that buybacks instead of dividends are just fine -- at any price.  I guess that's because I see a lot of value in the dividend->capital_gain laundering pass-through.

 

And I'm happy if a corporate chieftain wants to pay me too much for my shares  ;D

 

if you are holding their stock then by definition it probably is not over priced and therefore. a good buy(back) for the company. If it is way overvalued chances are you are not holding the company.

[ERICOPOLY]

It will be interesting when I'm faced with 45% tax on dividends.  The after-tax dividend would need invested very capably in order to be a better idea than just reinvested in a fairly priced stock buyback.  I mean, I only have 55 cents left on the dollar for goodness sake!

 

Berkshire only pays a 5% tax on some dividends from equities, but they pay a 35% tax on capital gains.  So it seems like no surprise to me that Buffett pretty much prefers the cash dividend at all times.  Now, if you instead make his cash dividend 45% tax rate and lower his capital gains tax to 22.5%, then I'll bet he changes his tune.

[twacowfca]

It will be interesting when I'm faced with 45% tax on dividends.  The after-tax dividend would need invested very capably in order to be a better idea than just reinvested in a fairly priced stock buyback.  I mean, I only have 55 cents left on the dollar for goodness sake!

 

Berkshire only pays a 5% tax on some dividends from equities, but they pay a 35% tax on capital gains.  So it seems like no surprise to me that Buffett pretty much prefers the cash dividend at all times.  Now, if you instead make his cash dividend 45% tax rate and lower his capital gains tax to 22.5%, then I'll bet he changes his tune.

 

Yup.  WEB became a buy and hold investor back in the mid 1980's after a change in the corporate tax law made it very expensive to flip stocks with gains.  :(

[ourkid8]

Parsad, how about companies like PM who consistently repurchase their stock at any price.  The debt they issue to fund the repurchase is lower then the dividend yield of the shares they are repurchasing.  Doesn't that make good financial sense to continue to repurchase those shares under that scenario even if the stock is selling above its intrinsic value?

 

S

 

I never understood this behavior and I still don't.  I remember the general counsel for ITEX telling me that there are several studies that show share buybacks don't actually benefit shareholders signficantly in the long-run, and then I had to explain that was because most corporations paid any price for their shares, rather than only buying them back when they were well under intrinsic value.  This CNBC article is the same thing. 

 

http://www.cnbc.com/id/45400632

 

Share buybacks historically have not worked because CEO's implement them automatically, so that their compensation bonus targets are hit based on earnings per share.  If they can't think of anything to do with the cash, and don't want to face hostile proxies, they simply pay dividends which are inefficient or implement automatic stock buybacks.  But there is a big difference between the prices corporations were paying in 2007 to buy back their stock and what they are buying them back at today.  A good example was Teledyne, or even when Prem bought back 10% of Fairfax's stock in the early 1990's.  You buy it back only if it is dirt cheap and fully accretive.  Cheers!

[oddballstocks]

I think the problem with buybacks is a behavioral one, most (all?) CEO's are always bullish on their company and seem to always believe it's undervalued. 

 

If a CEO is a prudent capital allocator then I think buybacks can be good.  If they're the classic run of the mill CEO then buybacks are a waste of money.

 

I had a public company as a client, they were buying back their shares at $40 to no end in 07 early 08.  The stock cratered in 08/09 to $8, and the CEO was asked why not buy back stock now, if it was cheap at $40 then it is cheaper now.  And I remember him saying that he thought the stock was probably a good value but they'd rather have the cash.  Well if they hadn't blown the cash at $40 they'd have it at $8. So instead they started issuing bonds at 14% at the market bottom of 09. The stock is back in the $40s and they're buying back again.  To tie this into my other point I saw how they managed capital allocation on internal projects and it was as misplaced as the stock buybacks.

[MrB]

Ericopoly,

a) Do companies in the US buy back stock with pretax or after tax earnings? Put another way, does the money a company use to buy back stock reduce its taxable earnings?

b) What is the rate at which capital gains get taxed in the US?

c) Does it make a difference to the rate capital gains are taxed at whether you sell say after one year or 5 years?

 

Thanks in advance.

[MrB]

A few years back, when Tesco anounced it was returning GBP 1Bn to shareholders I asked the CFO to run me through their decision tree when deciding on how to return funds to shareholders. His response, Mumble, mumble, mumble. I then asked how price futures in their thinking when considering a buy back. His response, Mumble, mumble, mumble. I then said, "Let me put it this way. If you buy back your stock, is there any price you will not pay for your shares?" His response, "No"!

 

Now appreciate this. This fella was a cracker jack, certainly a brilliant CFO. Tesco is a top notch company with some of the best managements in the world. However, most managements and capital allocators have a blind spot just as many on this board will argue that the vast majority of investors just don't get it. The problem is that we don't realize how few people think like us. Only 0.5% of fund managers beat the market by more than 3% over the long run and most of them seem to be value investors.

 

So my point is that to expect sensible buy backs...well, it is a tall order. Conversely, don't underestimate the risk in capital allocation. It sometimes takes these companies a decade to build the value in a firm and they can destroy half that value with one decision, be it a buy back or takeover at the wrong price. This usually happens within 12 months of me buying the stock! ::)

[oddballstocks]

I'm not ERICOPOLY but I can answer

 

a) After tax money, really from the company's perspective it's the same as paying a dividend.

b) 15% for stocks held one year and a day, less than that is ordinary income, so 25%, 33% or 35% tax rate

c) The rate doesn't change once a year is exceeded, it stays at a flat 15%

[MrB]

Ok thanks.

One more. What is your tax rate on dividends, please?

[oddballstocks]

Dividends are taxed at 15% as well no matter how long you've held the stock.

[Liberty]

I love buybacks when they are done right, but I agree with others here that unfortunately, that is rarely the case.

 

The best historical example is no doubt Teledyne.

 

Among the companies I follow closely, I really like how Altius bought back over 2 million shares at very depressed prices in 2008-2009. Also love how EBIX just bought back close to 10% of the company way below what I consider to be IV. I think Bill Berkley of WRB has a pretty good record with buybacks too.

 

I think part of the problem (and solution) is incentives. Some managers are probably decent capital allocators, but it pays more for them to reach certain EPS and SP targets, so they do stupid buybacks. This temptation is reduced when you have an owner-manager who owns a large fraction of the business, as in the case of the examples above.