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Minyan Mailbag: Why are Share Buybacks a Bullish Thing?


Company share buybacks have to be viewed in context.

Prof. Succo,

Am I missing something with all the record share buybacks over the last year or so? My personal tipping point is the Home Depot (HD) announcement Thursday of another 1B in buybacks (now of course they don't have to do it (wink, wink), but the announcement lately has been enough to move the stocks of these companies). Why is this a bullish thing? I see on the other side of the trade that "the stock is undervalued and management sees opportunities," etc, etc. Wouldn't rational thinking portray this, in a revenue declining environment (as evidenced by the 4th Q earnings season), as a blatant attempt to "manage" earnings and as bearish in actuality? Now, nothing surprises me when Fannie Mae (FNM) rallies seemingly every day and sentiment does not turn unless bad news continually comes out rapid fire. Isn't the "stock market" supposed to be a giant "discounting mechanism" that looks out into the near future? The bond market is clearly "telling" us something and I guess this is another example of the disconnect out there.


Minyan Steve


The discounting mechanism of the market works over a long period of time, but can become "broken" in the short run. Machinations like Fed intervention (excess monetary policy, buying risky assets) and company buy-backs can incorrectly influence the perception/sentiment of investors over the short run, but long run fundamentals eventually manifest and correct those mis-perceptions.

Company share buybacks have to be viewed in context. What does it mean when companies buy back their shares when stock prices are high, along with multiples, with excess cash on the balance sheet? In the short run it improves earnings as the company retires the float (number of shares outstanding): EPS per share increases with the fewer shares. But when share prices are high you have to ask, isn't the company better off by investing that cash in expanding their business (capital investment) if the company is so bullish on its prospects?

In 1987 when stocks were on their lows, companies came out and announced share buybacks because they felt the best way to invest in their business was to buy back cheap shares.

When companies are buying back shares when they are high with cash from excess Fed liquidity, it tells me they are having trouble making earnings in the short run because they cannot find a reason to expand their output.
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