Are Companies Buying Back Shares to Trick Investors?
We all have our own unique pet peeves that drive us crazy, and I am no exception. More grating than fingernails scraping down the chalkboard or rude drivers who refuse to let you merge lanes are those citizens that unabashedly exercise poor public bathroom etiquette. The only thing worse than listening to the loud-mouth cell phone talker in the neighboring stall is watching a restroom participant move straight from zipper closure (if they remember), immediately to the bathroom exit. I mean really, would it kill you at a minimum to pay a visit to the sink and feign a phantom hand-swipe under some running water? Don’t those people understand that I have to grab the same handle they use to exit the facility after they conduct their bathroom business? OK, now that I have gotten this issue off my chest, I feel better and I can get off my soapbox (no pun intended).
Something Stinks in Share Buyback Land
Beyond potty etiquette, there is another maddening pet peeve that drives me nuts in the realm of corporate capital allocation. I like to call this particular scheme the “empty share buyback.” Those companies that announce the empty share buyback do it with the intention of either getting a quick, short-term jump in stock price, or use the ploy as a way to indirectly line their pockets with future stock and option grants.
Here are a few ways on how the ruse works:
Scheme #1 – The Empty Pump-Fake: In one form or another, here is what the CEO basically says, “We plan to buyback zillions of shares from time to time, based on market conditions, and do not have any set expiration date for the plan.” In other words, the company executives are committing to absolutely nothing, but are hoping to confuse traders into buying shares to temporarily increase the stock price, so management can unload their shares for a swift profit. In actuality the management team is not obligated to purchase one share and may keep the pseudo-share buyback plan in place for years with no benefit to shareholders.
Scheme #2 – The Pocket Swap: Another one of my favorites, I like to call the pocket swap. Management effectively exchanges money from one pocket to the other. Typically management starts off by stating, “We treasure investor feedback, so we have initiated a new program to return capital to our valued shareholders in the form of a share buyback.” What they usually don’t tell investors is that the shares are being purchased (with shareholder money), so the executives can give more shares back to themselves (and a few other fortunate employees). That’s great for them, but what about me?!
At the end of the day, if the management team is truly working for the shareholder, the game is all about reducing the outstanding share count, which thereby increases earnings per share (and better yet free cash flow per share). Despite the recent climb in interest rates, yields are still near multi-decade lows. Corporations are flush with cash after cutting expenses to the bone, delaying hiring, and riding the global recovery wave. For those real investors not trading a position for a few days, weeks, or months, it behooves you to hold management’s feet to the fire to make sure “empty pump-fakes” or “pocket swap” share buybacks are not occurring.
If you have difficulty gauging the integrity of those management teams announcing share buybacks, I have a litmus test that can be used to judge the executive’s true intentions. It’s quite simple – just follow the CEO into the bathroom (same gender required) and see whether they honorably follow bathroom etiquette by washing their hands after completing their duty. Sleuth work can be tricky, but failure in determining the genuine purpose of management’s capital allocation decisions can lead to a share buyback program that will get flushed down the toilet.
Wade W. Slome is a CFA and CFP® at Sidoxia Capital Management.
Disclosure: Sidoxia Capital Management SCM and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article.