December 18th, 2013
by EconMatters, EconMatters.com
Stock Buybacks at Market All-Time Highs: Poor Use of Corporation Capital
Era of Stock Buybacks
This has definitely been the era of stock buybacks with such low borrowing costs as companies are borrowing at very low rates not to expand the business, create innovative products, increase research and development but to buy back their own stock which isn't cheap considering the multiple expansion in markets the last five years.
But earnings from a revenue side have been subpar to say the least and companies are buying back stock each quarter just to make their quarterly numbers look better than they actually are based upon the year over year business growth.
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The funny thing is that this has been going on for four years, these are public companies right? At what point do the floats become so small that for all intents and purposes these are private companies? I am being a little facetious here, but this has to be the longest continuous era of stock buybacks on record all fueled by the Fed's never before witnessed five straight years with the Fed Funds Rate at near zero percent.
Is this the Best Use of Company Capital?
It is a real shame that these companies don't have some better use for this cheap government loans in essence than stock buybacks. How is the economy ever going to grow if these companies don't try to expand their businesses with this cheap capital, hire more workers, and thus have future customers for their products who are now employed consumers.
But with stock floats getting smaller and smaller and company stocks at record highs isn't this the opposite of buying low and selling high? The companies are buying their stock when it is extremely over-valued. Isn't the smart use of stock buybacks to buy back the company stock when the company thinks that the shares are undervalued by the market? You know, buying low and selling high, doesn't this just make for good business practices?
50% Losses on Buybacks?
By my thinking most of these stock buybacks are going to be underwater once QE ends this summer of 2014, and the stock buybacks are going to be net losses for these companies down the line. How do responsible boards allow this type of behavior, buying back stock at exceptionally high levels?
Furthermore, once interest rates start rising and companies have to start raising capital where do you think it is going to come from? These same shares are going to return to market at much lower prices, further pushing stock prices down vie share dilution. This is the exact opposite of how a solid business would want to manage operations, cash on hand, borrowing, and managing stock buybacks.
The reasoning is that this is all setting up future earnings to be real bad when all these shares come back to market for equity raises, which you know is inevitable, and these stocks are going to have just terrible quarters, further sending their stocks down in the process.
Market Crash Inevitable
All the factors are coming together for quite a correction in stocks at some point down the line, and this is just another example of buying time now, but paying a heavy price in the future. All of which further exemplifies why we are going to have another huge market crash, the boom and bust cycle of credit markets, and how every investor better be damn good at market timing. There is no other choice with these types of poor cash management issues at companies.
Misplaced Incentives Short-term in Nature
The cynical side of me who has worked at many fortune 500 companies sees this as the real motivation or at least a driving force. All the executive team, all the players at companies receive stock options in compensation packages, stock buybacks not only help shareholders right now with increased returns, but all these 'big dogs' at these companies make a fortune on these stock options with stock prices higher each consecutive year, and each successive month for 2013.
The delta between the issue price, and when they exercise these options is incredible right now, and the incentive to push these compensation packages through the moon via stock buybacks, even with the market at all-time highs, is just too good for these executive teams to pass up right now.
Retirement Golden Options Plan
In addition who cares if this is a poor use of company resources, if these shares are going to be largely underwater in three years, with the money these executives ( and we are not just referring to CEOs - employees who receive options can be quite broad from a numbers standpoint at large firms - all at the upper management level of course) make on these stock options they can retire comfortably, and they probably aren't even going to be around at these firms when the proverbial mess hits the fan at these companies.
Boards Same As They Always Are - Borderline Incompetent
Consequently again I ask where is the board in all of this excessive use of stock buybacks quarter after quarter? Aren't they supposed to be the checks and balances for this type of short-sighted behavior? I thought we learned something from the "Enron Era" of good old boys Boards!
When I heard Kyle Bass discussing one of the reasons he was investing in Herbalife because he thought after the audit is completed that Herbalife will be able to borrow at 300 basis points to buyback future stock at all-time highs - I just shake my head as this isn't going to end well folks!