by Eric Englund
a talking head, on CNBC, proclaims that Company X has announced
a stock buyback, it is unfailingly hailed as good news for
shareholders. After all, in the world of high finance, cash
is trash, leverage is good, and stock buybacks can boost earnings
per share and the price of the stock itself. When stock buybacks
are executed judiciously, shares are purchased when management
recognizes that the stock is undervalued – as it is preferable
to buy while the price is low (at least that’s the theory).
All of this is done, of course, under the guise of enhancing
shareholder value. Hence, what is good for the shareholder
(i.e., a stock buyback) must be good for the company itself.
This is exactly what the charlatans, of Wall Street, want
you to believe; and it is a lie.
distress, besieging America’s largest financial institutions,
exposes the pernicious nature of stock buybacks. Call me old
fashioned and financially conservative as I have never agreed
with the idea that weakening a company’s balance sheet is
beneficial for the company and its shareholders – yet, it
does benefit a very select group of shareholders and this
will be covered below. Repurchasing shares weakens a company’s
balance sheet in three key ways in that cash, working capital,
and equity are diminished by the dollar amount of the shares
repurchased. When a company’s stock-buyback program, over
time, adds up to billions of dollars, the negative financial
impact can be staggering.
prices, of America’s largest banks and brokerages, have been
getting hammered. Yet the declining stock prices fly in the
face of the "wisdom" of buying back shares in that
a scarcer number of shares should lead to higher stock prices.
The following table, comprised of seven high-profile American
financial institutions, neatly exposes the falsehood that
stock buybacks increase shareholder value.
2001 Through 2007
fiscal-year 2001 through fiscal year-end 2007, these seven
companies have repurchased $127.3 billion of their common
stock. I would argue that each company’s stock-buyback program
actually intensified the downward pressure on the price of
their respective common shares.
well known that there is a global credit crisis and that investors
are nervous about which financial institutions will or will
not survive through these uncertain times. Top-notch financial
strength, consequently, is viewed as a virtue. Thus, it stands
to reason that had each of the above-mentioned companies not
engaged in such reckless stock buybacks, each company would
possess a dramatically stronger balance sheet. In turn, better
financial strength provides a company with a greater chance
of surviving difficult economic circumstances and, accordingly,
would be reflected favorably in the price of its common shares.
Return, to any one of these companies, the money it squandered
on stock buybacks and you’d see a company with a higher stock
price than currently bestowed by the marketplace.
test, a little more, Wall Street’s "logic" with
respect to share repurchases. If a stock buyback is good for
a company, shouldn’t buybacks take place when times are tough?
After all, during tough times, shouldn’t management do good
things for a company? Moreover, if stock prices have dropped
precipitously, shouldn’t management be repurchasing shares
hand-over-fist? The actions, of the seven aforementioned companies,
speak volumes about such questions; and exposes stock buybacks
as nothing more than a Wall Street scam.
the first five months of 2007, these seven financial institutions
bought back $14.4 billion of their common stock. Through the
first five months of 2008, the same exact companies repurchased
only $786 million of their shares – a reduction of nearly
95%. It is painfully clear that each company’s management
team has determined now is not the time to further weaken
their respective balance sheets. Corporate survival may be
at stake. After all, share repurchases would further erode
the balance sheet and the share price may suffer even further.
So, when is it ever a good time to weaken a company’s balance
Hathaway’s 2005 annual report, Warren Buffett criticized executive
compensation schemes in his letter
to shareholders. In the following example, Mr. Buffett
makes it quite clear that a company’s top executives and managers
can be compensated handsomely even if the company’s performance
is mediocre or poor. At the epicenter, of such a compensation
scheme, is management’s control over whether or not to engage
in stock repurchases. Read it and weep:
often, executive compensation in the U.S. is ridiculously
out of line with performance. That won’t change, moreover,
because the deck is stacked against investors when it comes
to the CEO’s pay. The upshot is that a mediocre-or-worse
CEO – aided by his handpicked VP of human relations and
a consultant from the ever-accommodating firm of Ratchet,
Ratchet and Bingo – all too often receives gobs of money
from an ill-designed compensation arrangement.
for instance, ten year, fixed-price options (and who wouldn’t?).
If Fred Futile, CEO of Stagnant, Inc., receives a bundle
of these – let’s say enough to give him an option on 1%
of the company – his self-interest is clear: He should skip
dividends entirely and instead use all of the company’s
earnings to repurchase stock.
assume that under Fred’s leadership Stagnant lives up to
its name. In each of the ten years after the option grant,
it earns $1 billion on $10 billion of net worth, which initially
comes to $10 per share on the 100 million shares then outstanding.
Fred eschews dividends and regularly uses all earnings to
repurchase shares. If the stock constantly sells at ten
times earnings per share, it will have appreciated 158%
by the end of the option period. That’s because repurchases
would reduce the number of shares to 38.7 million by that
time, and earnings per share would thereby increase to $25.80.
Simply by withholding earnings from owners, Fred gets very
rich, making a cool $158 million, despite the business itself
improving not at all. Astonishingly, Fred could have made
more than $100 million if Stagnant’s earnings had declined
by 20% during the ten-year period.
stock repurchases benefit a narrow group of corporate insiders.
Not only can such insiders benefit while the company remains
stagnant, they can financially benefit while simultaneously
demolishing the company’s balance sheet. A perfect example
can be found at Citigroup.
saw above, Citigroup was the most aggressive company when
it came to repurchasing shares. Over the past three quarters,
Citigroup has suffered a cumulative net loss of $17.4
billion. To be sure, these losses were "baked in
the cake" ten to fourteen quarters ago when Citigroup
was speculating in mortgage-backed securities, extending shaky
loans, entering into risky transactions with the monoline
insurers, and participating in speculative leveraged buyouts.
Credit standards were set irresponsibly low so that revenues
and net earnings would go sky high. And, in order to goose
Citigroup’s stock price and executive compensation, Citigroup
engaged in nothing short of an orgiastic stock buyback program.
It worked for a while with the stock peaking at nearly $56
per share in December of 2007. Now, the chickens have come
home to roost as Citigroup’s share price has collapsed by
Vikram Pandit became Citigroup’s CEO eight months ago, he
has been instrumental in raising $40 billion in new capital
for Citigroup. As stated in this July 15, 2008 International
Herald Tribune article,
Mr. Pandit "…is trying to turn around Citigroup as the
banking industry struggles through one of its most challenging
periods since the Depression. His task is particularly difficult
because many Citigroup bankers, paid with stock and options
for years, have seen their fortunes vanish. Morale is low."
I have no sympathy for these demoralized Citigroup executives
and managers as their "fortunes" were built upon
a financially destructive stock-buyback program pyramided
upon intellectually bankrupt business and credit practices.
next time you hear a CNBC talking head gush over a company’s
stock-buyback announcement, think of Fred Futile and his self-dealing
management style. To praise the weakening of a company’s financial
condition reveals the vapid nature of financial reporting.
More importantly, the incredible amount of stock repurchased
by the seven above-mentioned financial institutions exposes
the intellectual and moral rot of countless business managers
and their Wall Street enablers. Not a single analyst has cried
"foul" and questioned the grotesque balance sheet
mismanagement of any of these financial powerhouses (or, more
accurately, former powerhouses). To me, this further reinforces
my core belief that Wall Street exists to redistribute wealth
from the poor and the middle-class to the wealthy. To deny
this is to remain comfortable dealing with liars and thieves.