stock buybacks are just a corporate finance tool, not plutonium

Some people declare their irrelevance to the conversation the moment they open their mouth.

Today, it was Mr. Enshitification’s turn with this article castigating stock buybacks.

It follows a very simple narrative.

buyback narrative: financial products --> finance
 --> money --> corporate greed --> hate the rich

Who would’ve thought that a basic tool of corporate finance was to become radioactive material.

The faulty logic (or perhaps its ignorance of basic rules of arithmetic) is amusing but dangerous because it comes charged with passion (of the wrong kind). Here’s an excerpt:

Say a company has issued 1,000 shares, and they’re selling at $1,000 per share. That company has a “market cap” of 1,000,000 (1,000 x 1,000). Now the company takes 500,000 out of its bank account and buys half of those shares. Now you have a million-dollar company with only 500 shares, so each of those shares is now worth 2,000 (1,000,000/500 = 2,000)

Doctorow understands that the share price is equal to the “market cap” divided by the number of shares, but naively fails to connect “market cap” with the value of the company itself.

All else equal, if a company spends 50% of its market cap in buybacks, its market cap falls by 50%. So in the example above, the million-dollar company becomes a half-a-million-dollar-company with only 500 shares, so each of those shares is worth $1,000 post buybacks (500,000/500 = 1,000).

There’s pontification, accusation, and rage in the article. How about pointing to a single fucking company that has been able to move its share price up through share buybacks?

what can buybacks really do?

increase fragility

For one, Doctorow’s intuition about the company’s future hits close to the mark:

By zeroing out its cash reserves, the company has actually reduced its value by more than the value of those reserves, because it is now stuck in place, forced to fund expansion with debt rather than capital. It is at risk from “shocks” like higher rents or higher energy prices.

The above observation is something that the MBA finance nerds cannot grasp. The company is more fragile to shocks, to black swans.

increase EPS

What stock buybacks do for sure is increase a company’s earnings per share (EPS) because there are fewer shares outstanding for the same amount of earnings. The stock price doesn’t move though (given the lower cash balance that, in turn, translates into a lower market capitalization).

An increase in EPS, however, can translate into higher compensation packages for executives, as EPS is sometimes a factor included in the formula for bonus payouts.

one exception: market dislocations

There’s only one case I can think of when share repurchases can really make a difference for shareholders: price implosion scenarios.

If a company’s stock price, for whatever reason, is trading well below its intrinsic value, deploying capital to buy back shares is a great investment. To be capable of this, however, real balls of fire are needed because the buyback has to be executed swiftly and in a large magnitude… and no one does it this way. Almost no one… I can count in one hand the number of companies who’ve done this in the last 60 years.