The Folly of Stock Buybacks-Part II
While outperformance, in general, may be an accurate statement, the authors studies fail to take into account those firms which have bought back large amounts of stock, and then, because they lost the financial flexibility to withstand economic or business turbulence, entered into a period of distress. Many of these firms later re-issued shares at considerably lower prices to stave off bankruptcy or merely compete during the ensuing period of economic weakness.
But financials were not alone in playing the stock market. Firms from Acme Packet (APKT) to Macy’s (M) to Wynn (WYNN) have been weakened from buying and selling their own shares over the past 5 years in an attempt to market time their stock, even though history clearly showed they would have been better off retaining that capital for expansion and value-adding acquisitions.
There are currently 112 active firms (excludes the failed firms) which both bought back and sold at least $ 250MM of their own shares over the past 5 years.
As seen in the table below, MGIC Investment Corp. (MTG), the insurer of home mortgages, and previously a “AAA” rated credit, was giddy about buying back their stock. When mortgage defaults hit, along with the value of their investment assets, so did their financial flexibility, a direct result of its $2.5 billion in share repurchases. Later, MGIC , was forced to increase their share count by 55% just to regain 73% of what they spent back! If they never bought back a share, its current share count would be 24% less..
Perhaps the second biggest flaw of the buyback advocates argument is it fails to take into account how the superior manager could have made use of that cash. That is why executives are paid- to create ever increasing value for shareholders. By buying back shares, managers are in effect saying, “We can’t do that.We intend to live and die with the assets currently on the books.”
Apple Computer (AAPL) has been generating billions of dollars in excess cash for years. Why hasn’t Steve Jobs forced the company into a share repurchase program? On the other hand, Microsoft (MSFT) has had the largest buybacks ever at $80 billion combined. What has it done for their shareholders, given the plaudits given by security analysts at the time of their announcements, both of which led to initial rallies in its stock.
To give management of a firm which, by its nature, generates free cash flows, kudos because their stock has outperformed, is poor logic, as the outperformance was not a function of the buyback policy but its products and employees. The share prices of these firms would have outperformed independent of its buyback policy had the cash remained on the balance sheet, just as it has with Apple. If anything, management of these firms are hurting shareholders by not re-deploying that capital into assets that would in-turn produce even greater free cash flows. They should be engaging in value creating opportunities, and with it demonstrating superior managerial skills. Stock buybacks take no skill and, since they do not provide shareholders superior long-term returns, should be considered in the setting of executive compensation. Executives whose pay packages are influenced by GAAP measures, and not cash flow based ROIC measures, are in my estimation, stealing from the shareholders!
If the stock market rallies, expect, as always, Boards of Directors to approve increasing allocations to share repurchases.
Thus, the biggest reason not to engage in buybacks, as shown by our previous article on this subject (The Folly of Stock Buybacks), is while buybacks aids shareholder (GAAP) reported earnings, it does nothing to improve economic return. And that’s where the argument ends.
Related Articles: The Folly of Share Buybacks
Disclosure: No positions
Kenneth S. Hackel, C.F.A.
President
CT Capital LLC
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