Meridian Star

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March 11, 2014

How investors may be getting fooled by buybacks

(Continued)

NEW YORK —

Many investors assume shrinking shares automatically make remaining shares more valuable. The math is seductive. A company that has $100 in earnings and 100 shares will report $1 in earnings per share. But eliminate half the shares and the same $100 is spread over 50 shares, and EPS doubles to $2.

But that doesn't make the shares more valuable.

Shares aren't just a claim on short-term earnings. They are an ownership stake in an entire company, including R&D programs and its capital stock — the plants, equipment and other assets needed to boost productivity long into the future. Critics say the lavish spending on buybacks has "crowded out" spending on such things, which is at its weakest in decades.

"It's just like your car depreciating or your home depreciating — you have to invest," says Gluskin Sheff's Rosenberg, "The corporate sector has barely preventing the capital stock from becoming obsolete."

One result: U.S. productivity, or output per hour, increased just 0.5 percent last year, a pitiful performance. It has grown by an average 2 percent a year since 1947.

If not reversed, history suggests stocks will suffer. In a 2010 study, Fortuna's Milano found that stocks of companies that spent the most on buybacks vastly underperformed stocks of those that spent the least on them — at least over five years.

It's unclear whether the kind of investor who dominates stock trading now cares about the long-term, though. Buybacks are one of the few sure-fire ways to push a stock higher in the short term, and investors these days are very short term.

They "don't care what happens in three or five years," laments Rauscher, the Baird strategist. "The market has become less of an investor culture, more of a trading one."

 

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