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Share buybacks, the raging bull and roosting chickens

A number of analysts and sources are observing the return of companies repurchasing their share. For those enjoying the raging bull market we are currently in the midst of (with record highs across major US indices), this may portend greater gains, but for those of us who are familiar with the cycles of leverage, booms are frequently followed by busts.

Prior to the onset of Covid, share buybacks, in the extraordinary low interest rate environment, were one notable source of support for stock markets. When a company repurchases its shares, it leaves fewer shares available for the market and also fewer shares that benefit from its future earnings. For both reasons the shares trade at a higher price.

The chart below is a great graphical demonstration of the phenomenon and Barrons engages with the issue in this article (subscribers only).

It shouldn't really be such a controversial issue. The arguments for it are that it is simply another form of returning money to shareholders (the other being paying dividends).

However, share buybacks are certainly better than paying dividends if you want your share price to go up. This may not make much difference to regular shareholders (who get their cash either way), but it does make a difference to management stock options, as the Barron's article points out.

That said, 10 year US Treasury yields at 1.2% make a business school case for it too. With the cost of debt capital as low as it has been in decades, so risk adjusted return on capital models, and enthusiastic bankers who rely on such models may even advise members of the board that these measures are sensible.

How convenient, sensible measures, that also boost the value of stock options - a wonderful win-win.

For those of us who are more cynical about the creation of easy money, it may make sense to focus on the increasing leverage within the corporate sector. When the cycle turns, as it inevitably will, there will be some companies for whom becoming more leveraged, by issuing debt, to boost their share price (through buybacks) will prove to have been a fatal mistake, as they fend off bankruptcy.

For litigators it is well worth taking note these short-sighted escapades of board members and their banking advisors.

Should you need an Expert Witness to support you in a banking or finance related matter, please do not hesitate to contact us.

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