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The problem with share buybacks

Recently many publicly traded companies have spent huge amounts of money buying back their own shares. Why is this happening, and why is it a problem?

Economics 101: be careful what you incentivize. CEO’s are incentivized primarily on share price performance. In theory that means incentives are structured to grow the business. But markets respond primarily to growth in profits, which is not necessarily the same thing as growing the business (see IBM). But using corporate cash to buy back shares – essentially messing with the supply side of stock to drive up price – is yet another way to raise share prices independent of the business fundamentals. However it is one more structural force driving the “rich get richer at the expense of everyone else” economy. Because people who already own shares get all the benefit, and ownership of shares is disproportionately in favor of the already wealthy.

Now what about share price in general? How reliable is it anyway? How are they set?

Shares are “worth” whatever they are trading for that day. Very many factors go into creating the daily price, many of them not even visible to pros. Whole sectors move together, international currency fluctuations, short term guesses as to the impact of politics, behind the scenes plays, rogue algorithms, competitor press releases, etc. All anybody does is guess. Some guesses are more educated than others, but they are all just guesses.

Trends move over time, but even they are subject to overall economic conditions. This is why most of the meaningful measurements are “relative to market” or “relative to industry”. So your stock went up 5%. Great. Unless all the other stocks went up 10%, in which case… not so great.

Taken as a whole, markets are weird. Full stop. They are full of people who believe they have identified an intrinsic value that is above or below market value, and trade on that assumption. Statistically such trades are as often wrong as right. As an analyst you can be right on all counts, and it still doesn’t mean the market behaves “rationally” in the instance of the company you are evaluating, within the time window you are able to trade in.

Since at least the 1970’s there has been a serious argument that individual investors have no chance at playing the public stock markets and beating the averages over the long term. Especially since 70% of the pros fail to beat their benchmark averages. Hence the ever-increasing popularity of index investing.

My interest in this area is more from the point of view of public policy. The rules (of accounting, or stock market listings) are not arbitrary, nor are they “natural”. They are just what a group of people agree on. However, the rules inevitably tilt the playing field (one way or another) eventually changing the whole of society. Thus, the type of society we live in is at least partly the product of the rule we agree to live together under.


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