Wednesday, December 10, 2008

Share buybacks!

A-ha! In my previous post on owning stocks, I had completely forgotten about stock buybacks, when the company uses excess cash to buy outstanding shares. In this sense, the company itself is placing real value on the stocks, and this gives them some intrinsic value other than (a) producing dividends or (b) liquidation.

The traditional reason for a stock buyback is apparently that the company claims this is a better way to invest its cash than anywhere else...and it gives an advantage to existing shareholders by boosting the share price, and when these shares are sold the profits are taxed at the lower capital gains rate (while dividends are taxed as income). But buybacks can also be used to manipulate the topline numbers in earnings reports (the earnings per share goes up if you remove shares!). I think that buybacks can also be used to prop up a sagging share price...kind of like a central bank propping up a falling currency, which can be an expensive proposition that doesn't always end well.

In any event, as stock prices have fallen in the past year, there have been a lot of stock buybacks. And apparently, over the past four years S&P 500 companies as a whole have given out more money in stock buybacks and dividends ($2.6 trillion) than they have gotten in earnings ($2.4 trillion). I suppose that (a) that can't be sustainable [but hey, a good reason to have stocks as long as you sold them!] and (b) probably involved a lot of leverage.

But I wonder how much of this money going back to shareholders has been due to companies going private, such as the Tribune company. There was a case that Sam Zell borrowed a lot of money to buy out the shareholders, and now Tribune is bankrupt under all that debt...even though all of the Tribune holdings are profitable!

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