Here We Go Again: Buybacks, Greenbacks and Bubbles

I had posted earlier about the paradox of companies buying back their stocks in bull markets when shares are most likely to be overvalued. Why do they do that? Here’s what I wrote:

[E]xecutives would like to exercise their stock options when they are in the money (or profitable), which is the case when the stock price is high. So they buy back shares at low pre-agreed-upon prices to resell them back into the market at their boom prices. In which case, management is a rational investor, but an irrational executive, which is a moral hazard problem. In other words, management is acting in its own interest, and not the company’s best interest. This seems the most likely to me.

Well, guess what? They’re at it again. From a recent Wall Street Journal article:

Last year, the corporations in the Russell 3000, a broad U.S. stock index, repurchased $567.6 billion worth of their own shares—a 21% increase over 2012, calculates Rob Leiphart, an analyst at Birinyi Associates, a research firm in Westport, Conn. That brings total buybacks since the beginning of 2005 to $4.21 trillion—or nearly one-fifth of the total value of all U.S. stocks today. [link]

The article goes on to talk about how stock buybacks should happen when shares are undervalued, at which point they are good for the investor. Several empirical studies  show that buybacks are perceived as a strong, positive signal by investors, which is reflected in the stock price, post-buyback-announcement. But of course, the reality is that most buybacks happen in bull markets. From the same article above:

To be sure, corporations should favor a buyback when shares are trading below the total value of their future cash flows and when capital expenditures or acquisitions don’t appear likely to offer a higher rate of return. And investors ought to welcome a repurchase, since it should increase earnings per share—so long as the company isn’t overvalued and can finance the buyback cheaply.

Yet companies tend to exhibit the same perverse timing—buying high and selling low—as individual and institutional investors. As the market hit a then-record high in the third quarter of 2007, corporations bought back more than twice as much of their shares—$214.3 billion worth—as they did in the depths of the bear market. In the final quarter of 2008 and first quarter of 2009 combined, repurchases totaled only $97.3 billion.

The study that’s linked above is an excellent one by Michael Maboussin and I highly recommend you take a look at it. Here’s a key paragraph from that study:

From 1985 through 2011, spending on capital expenditures was roughly twice that of M&A. Spending on M&A was about 50% higher than dividends and buybacks combined. So for every dollar spent in these four areas, roughly $0.55 went to capital spending, $0.27 to M&A, and $0.18 to dividends and buybacks. [link]

So about 18% of capital expenditures on average go into stock buybacks. I wonder what that figure was this year? Maboussin says, in the article:

“At the bottom, everybody sits on their hands,” says Michael Mauboussin, head of global financial strategies at Credit Suisse. “They don’t do anything when stocks appear to be cheap. But when stocks are expensive, then they buy back shares hand over fist.”

Cough bubble cough. Pardon me, must be something stuck in my throat…

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