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!

What's the purpose of owning stocks?

Something I was thinking about the other day...what is the value of stock in a publicly traded company these days? According to the wise people at wikipedia:

A share of stock is one of a finite number of equal portions in the capital of a company, entitling the owner to a proportion of distributed, non-reinvested profits known as dividends, and to a portion of the value of the company in case of liquidation.

But these days, companies don't really pay dividends. I think this trend started during the tech bubble, when people still bought stocks even when there wasn't any revenue, and therefore there weren't any dividends...so other companies said "wait, what? We don't have to pay dividends?"

So the only value to a stock is if the company is liquidated (or sold). If the company is liquidated in the usual sense (bankruptcy) then the stock is worthless.

It seems to me that the only reason to buy stock (in most companies, where you don't have any voting rights to determine the direction of the company) is to speculate that the value will go ever upward. This sounds a lot like the foundation of sand underneath the financial crisis, that everything would be fine as long as house prices went up forever. And if they didn't? Well, we didn't even contemplate what would happen.

I am certainly no economist, and the more I read the less I understand. But it's another sign of the way our whole economy has divorced itself from producing anything, and is more about moving money back and forth and making money by taking a cut of every transaction. That can't bode well.