I’ll bet you didn’t see this one coming? According to today’s WSJ headline, Stocks Biggest Gains Are and Inside Job. It’s one thing to shop for the date of record, even if you do not plan to hold. But a strategy of looking those subject to a buyback? Not a likely strategy. When prompted with the question, “Quick, what is the stock market’s biggest driver today? Corporate earnings? Interest rates? The Federal Reserve?” My immediate response is, perception of all the above. But some have suggested another possibility:
Some say the correct answer is something people rarely discuss: companies buying back their own stock. Companies purchasing their own shares represent the single biggest category of stock buyers today, according to a study this month by Jeffrey Kleintop, chief market strategist at brokerage firm LPL Financial.
In a remarkable statement from the LPL strategist, “only one other major group, individuals, is a net stock buyer now and individuals are buying less than corporations,” and this includes major groups of investors: “hedge funds, foreigners, insiders and investment institutions such as pension funds and insurance companies all are net sellers.”
But such a practice is quite subject to criticism, and for what seems to be somewhat self obviating reasons. Some of the first terms we learned in second semester accounting was, dilutive and antidilutive, as noted on Investopedia, “the effects of securities retirement…on earnings per common share (EPS), where EPS is increased for shareholders…[i.e.] by lowering the share count or increasing earnings.“ And the article goes on to speculate that, “some critics go so far as to say executives use buybacks to manipulate share prices, which helps them hit earnings targets, please investors, receive bonuses and avoid scrutiny from shareholders and boards.”
While the argument can be made for the tax benefits to the investor for such an action versus dividends, actions such as those by IBM are questionable. Specifically, on the face of it, there is nothing unusual about IBM using $8.3 billion of pent-up cash from the sidelines for a stock buyback. But it was quickly noted that Big Blue’s balance sheet reflected higher liabilities rising alongside the stock buyback and thus, debt fueling EPS. This actually comes down to the argument of intrinsic value and understanding all of the financial statements and how they tend to tell a more complete story, when taken together, rather than the obsession and fixation on the one, the income statement and earnings-per-share.