HENRY SINGLETON WHERE ART THOU?

While politicians and other critics have focused on stock buybacks being a poor use of cash versus investing in and growing a company, they have completely missed the boat.  As have those in the business press who have concentrated their critiques on the timing and high stock prices paid for these buybacks.  In so doing, all these parties have provided a smokescreen for executives of publicly traded corporations to continue their Chinese water-torture plundering of American’s savings.

Instead, the real charade of stock buybacks is that they have nothing to do with the shareholder and enhancing shareholder value, and everything to do with self-remuneration, as outlined in ‘The Skim and the Partial Ponzi.’

Yet a long time ago, buybacks really were very beneficial to shareholders, as they allowed good managers to take advantage of the inefficiencies and dislocations of the capital markets.  The underlying thesis behind value investing was that if a company’s ability to generate cash wasn’t recognized by the market, that excess cash could be used to buy back stock and shrink the float. If despite this buttressing, the stock price continued to languish, it could be done again and again as cash continued to pile up on a company’s balance sheet (now at an even faster rate due to the buybacks being accretive and increasingly so).  The key ingredient to all this was that the price of the company had to be undervalued.1

Nowadays though, stock buybacks are done indiscriminately, and usually executed very poorly.  The main reason for these “sloppy” buybacks is that they simply have to be done in order to offset dilution from employee stock and stock option awards.  Leading to the question:

What would happen if all publicly traded companies stopped buying back stock altogether?

Quite simply, the most noticeable and significant thing that would happen is the number of shares outstanding would balloon over time – exposing the ruse of reported net income and Return on Capital, as well as the true level of compensation corporations are paying out.  To what extent would shares outstanding grow?  1.4% a year if we use my conservative estimate, and 2.4% a year using the actual number as calculated in the Skim and Partial Ponzi.  While the annual numbers may seem small and inconsequential – which is exactly what corporate managements want you to think – the power of compounding brings home the reality of how much equity has been stolen from the retirement and savings accounts of American’s.

In the fifteen years of the 21st Century, had zero buybacks occurred in the S&P 500, the number of shares outstanding in the index would have increased between 23% and 44%!2

Now let’s get the caveats out of the way – the biggest being that without buybacks, cash would accumulate on balance sheets.  So instead, we just assume the cash was paid out as a dividend and also that executives would have to hold onto their stock instead of selling it in the public markets. Great, for 15 years you too would have directly received additional cash in the form of dividends – as would the executives of the companies who today would own almost one-fifth to one-third of those companies and diluting you.3  Yet it’s also important to keep in mind that the value of your stock, or index fund, would be reduced in price by a like amount, due to their being marked down quarterly by the amount of the dividend.

As an aside – via these dividends, corporate employees, primarily the top execs, would be receiving 1/5 to 1/3 of the earnings of the corporation directly, instead of in the covert manner currently being utilized of using earnings to buy back stock which they are selling.  Also, it’s important to note, that dividends, especially larger ones as we’re proposing here, wreak havoc on the value of employee stock options over time, because stock prices are reset lower after every quarter after the stock goes ex-dividend.  An interesting rationale for corporations to not favor this method of distributing cash – though they’d most likely attribute it to some “tax-efficiency” mumbo-jumbo.

In other words, in the 21st century, publicly traded companies have to buy back stock no matter what the price of that stock is!  This makes all the articles and critics deriding the amounts spent on stock buybacks4 due to their choking off growth, a moot point.  It also renders those ridiculing the high prices paid for shares of stock in a buyback inconsequential (but frustrating in it’s additional cost and insouciance to the collateral damage).

Of course shrinking a company, no matter how beneficial for shareholders, is anathema to the empire-building mentality of executives today. So we’ve got a better idea to motivate the decision makers to enact the right buyback and capital allocation strategies.  It’s coming soon in the solution to the Skim and the Partial Ponzi.  Stay tuned…

Why Management Loves Share Buybacks“Why is management at so many companies bereft of better ideas and more productive uses for corporate cash? Maybe it’s because so much of the proceeds of buybacks end up in their own pockets.”

Profits Without Prosperity“Since the late 1980s, the largest component of the income of the top 0.1% has been compensation, driven by stock-based pay.”

What $1.5 Trillion in Share Buybacks Doesn’t Buyhere’s a recent example of a very good journalist getting smoke-screened by the critique that buybacks are bad because they divert from capital investment, and therefore missing the real story

Dell’s Up’s and Down’s with Optionsthis great article makes the mistake of focusing it’s anti-buyback fervor on the prices paid to buyback stock.  Nevertheless it provides a great history of how corporations massaged the rules to make dilution a mirage, and encapsulated the whole fallacy with this quote: “Dell has spent more on share repurchases than it earned throughout its life as a public company”

  1. Sure, this is a very discretionary measure.  I could just fallback and use Warren Buffett’s term of “selling for far less than intrinsic value in the stock market.”   But I’d prefer to hone in on a company’s ability to generate excess cash, both currently and going forward []
  2. 23% if you go w/ the conservative estimate, 44% with “actual.”  Here’s the math: Total earnings in the SP500 in 2015 = $964 billion.  58% of these earnings were spent on stock buybacks  = $565 billion.  78% of the $565 billion, was used solely to offset dilution = $440 billion.  The market capitalization of the SP500 is $18 trillion, and $440 billion/$18 trillion = 2.4% a year.  2.4%, compounded over 15 years = 44%.  Multiply these latter two by 25%/45% = .55 if you want to arrive at my conservative estimates instead []
  3. which also means that because the total dividend pie now has to be “fed” to more shares, it will also have to be lowered if there’s no earnings growth …something that’s more difficult, but not impossible, to achieve if $ isn’t being reinvested into the business. []
  4. whether they be in absolute terms or as a percentage of earnings []

2 thoughts on “HENRY SINGLETON WHERE ART THOU?

  1. “exposing the ruse of reported net income”

    You would have had a point to this claim before GAAP required stock option expensing, but now it’s not the case. The value of stock options granted to employees flows through the income statement as an expense and therefore depresses reported net income.

  2. Also, the math in footnote 2 might be a good effort for one year , but it doesn’t make sense to assume that the amount of dilution from incentive stock is the same every year. That number needs to be calculated each year. The $440 billion spent to offset incentive equity grant dilution also looks high, to the point of almost being implausible. What’s the source? Does it include gross equity issuance beyond just incentive equity such as stock issuance for cash and stock issued as consideration in acquiring other companies?

    You start with a reasonable overall thesis here – some amount of stock buybacks just offset incentive equity issuance to employees – but I take issue with some of the details.

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