Buy Back Blues

Why do companies buy back their shares?

It’s a fair question. A reasonably profitable company will generate excess cash, often more than it can use to grow. What should it do with it?

Companies have three options: hold it, pay it via dividends, or buy back shares. In the absence of taxes, investors should be indifferent. Money earned is money earned, no matter how the company distributes it. The financial impact of each approach is the same.

While holding excess cash might encourage management to do something stupid, and tax policies formerly favored buybacks over dividends, such is not the case now. So why do companies keep buying back their shares? Often management believes their shares are undervalued. Share buybacks can indicate confidence in the future; but they can also disguise mediocre performance by artificially enhancing financial ratios.

Some have suggested that share buybacks counteract the dilution due to employee stock option plans. This is a canard. If an option program dilutes shareholders, buybacks don’t counter this. They may disguise the dilution, but they don’t reverse it.

While share buybacks don’t create economic value for investors, they do send a signal. But the intelligent investor has to discern whether the signal conveys information, or is just a smoke screen.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350 • •
By | 2014-09-05T13:25:40+00:00 September 28th, 2009|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment