Robert, I read with
great interest your recent blog post demonstrating the relatively low ROI's
required to replicate EPS growth from equivalent share buybacks.
Your analysis suggests profound flaws in the two most common rationales
corporate executives give for their share buyback programs
1.
Our actions reward
shareholders by making their shares more valuable
2.
Our stock is
undervalued. Our actions reflect management's confidence in our growth
potential
The first argument may
be true for EPS, but not for long term stock price appreciation. The second
argument is even more galling, as your analysis suggests exactly the
opposite. Given your results, the only logical explanation to go ahead
with an aggressive buyback program is that management actually doesn't
believe it can generate even modest returns on its cash from current
operations. Or said another way, management is in essence saying they are
giving money back to shareholders because they have run out of ideas on how to
generate attractive returns within the company. Or course, the more
likely explanation for share buybacks is management bonus kickers based
on EPS. So much for CEO's and boards acting in the best interest of
shareholders.
I teach business
strategy in the MBA program at Columbia Business school where I share a
perspective that effective capital allocation is one of the most important
responsibilities of the CEO. To illustrate the point, I point to IBM who
has skewed its use of capital (including debt financing) towards share buybacks
at the expense of value-creating investments in R&D and capex. As a
result, IBM's R&D lags its technology peers, and not surprisingly (despite
aggressive acquisition activity), its revenues have declined for 15 straight
quarters. The attached figure graphically depicts these trends.
HP is another case of
the folly of favoring share buybacks over R&D in the tech industry.
Carly Fiorina is often criticized for her disastrous acquisition of Compaq, but
her successor Mark Hurd also deserves notoriety for slashing HP's R&D
expenditures while sizably expanding HP's share buyback program.
Shareholders who
maintained their investments in both of these companies through their periods
of substantial share buybacks have not fared well.
I'd be curious to
learn whether you've done any analysis tracing the stock price performance
(relative to the S&P 500) of companies who have been most active in stock
buybacks. Has management unwittingly practiced buy high/sell low?!
Len Sherman
Columbia Business
School
Attachments area
March 27th
2016
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