• Introduction
  • Large Stock Repurchases Are Not Being Funded by Debt
  • Repurchasers Are Not Starving Their Companies of Investment
  • Smaller Companies Have Some Different Dynamics, but These Differences Are Inconsequential in Aggregate
  • Conclusion

Introduction

Some politicians and pontificators have been in an outcry about the large amounts of stock repurchases being implemented by U.S. firms. Several media outlets have covered this issue over the past year with many claims about the topic. The primary causes of the angst over the high level of recent corporate stock buybacks seem to stem from:

  1. A growing concern that firms are raising significant debt to repurchase stock at elevated prices, thereby weakening balance sheets, which is reminiscent of 2007 shortly before the financial crisis.
  2. The perception that the primary motive behind the stock repurchases is often a desire to enrich management through the ability of stock repurchases to boost earnings per share (EPS) by decreasing the share count and potentially lift the stock price, which can trigger or increase performance-based management bonuses and grow the value of stock and especially stock options held by management.
  3. Fear that this “financial engineering” is disingenuous and enriching management at the expense of firm health, economic growth, investment in capital expenditures/R&D and long-term value creation.

While these concerns may seem valid, we have found that some of the claims made to support these concerns simply do not hold true for corporate buybacks in aggregate.

As one of many reasons to shudder at the thought of politicians meddling in complex corporate capital allocation decisions, many people consider the current situation to be of politicians’ own making despite attempting to do the opposite. In a Reuter’s Special Report entitled “Buybacks Enrich the Bosses Even When Business Sags” the authors discuss how politicians’ attempts to rein in executive pay actually had the opposite effect. They write: “In 1992, Congress changed the tax code to curb rising executive pay and encourage performance-based compensation. It didn’t work. Instead, the shift is widely blamed for soaring executive pay and a heavier emphasis on short-term results.” With many examples of harmful unintended consequences from politicians’ past efforts to correct relatively simple problems—in many cases causing dramatically worse problems—it should cause pause in any effort of politicians to meddle in a topic as complex and important to the economy as capital allocation.

Capital allocation decisions are among the most complex and important decisions for companies to make because they require a solid understanding of the opportunity set available to a business and a keen understanding of the competencies and strategic advantages of a particular company in pursuing an opportunity.

Instead of proposing solutions to the perceived problems being raised by politicians and others, in this paper, we merely want to use the data at our disposal to set the record straight in terms of the actual facts of the situation around corporate buybacks. In our humble opinions, it is an essential first step to understand a situation correctly before attempting to make significant changes to economic policy, tax laws or corporate behavior.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

January 25, 2016 |

Categories: White Papers

January 25, 2016

Categories: White Papers

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