The New York Times | Fair Game, March 25, 2016 column: "In Yahoo, Another Example of the Buyback Mirage" [Increasing concerns about illusions created by stock buybacks]

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Increasing concerns about illusions created by stock buybacks

 

Market reactions to the article below, which was published in the print edition of The New York Times on Sunday, March 27, are presented in the following video:

For previous Forum attention to issues addressed in the article below, see the "Stock Buyback Policy" section of the reference page for the Forum's 2014 project reviewing a buyback controversy, which includes in its chronological news list the following 2004 observations of the current article's author:

Note: The statements of the Forum's chairman reported at the conclusion of the article were intended to address examples in which competent management should have been able to make effective use of capital. As indicated in the March 18, 2016 Forum Report: Inviting Proposals of Candidates for Analysis of Stock Buyback Policies to which the article links, he does in fact recognize the benefits of buybacks when appropriate to return capital that is not needed to support a company's competitive production of goods and services.

 

Source:  The New York Times | Fair Game, March 25, 2016 column


Business Day

In Yahoo, Another Example of the Buyback Mirage


Fair Game

By GRETCHEN MORGENSON    MARCH 25, 2016


Marissa Mayer, chief executive of Yahoo. Credit Ramin Rahimian for The New York Times

It is one of the great investment conundrums of our time: Why do so many stockholders cheer when a company announces that it’s buying back shares?

Stated simply, repurchase programs can be hazardous to a company’s long-term financial health and often signal a management that has run out of better ways to invest in the business.

And yet, investors love them.

Not all stock repurchases are bad, of course. But given the enormous popularity of buybacks nowadays, those that are harmful probably outnumber the beneficial.

Those who run companies like buybacks because they make their earnings look better on a per-share basis. When fewer shares are outstanding, each one technically earns more.

But a company’s overall profit growth is unaffected by share buybacks. And comparing increases in earnings per share with real profit growth reveals the impact that buybacks have on that particular measure. Call it the buyback mirage.

Consider Yahoo. The company has bought back shares worth $6.6 billion between 2008 through 2014, according to Robert L. Colby, a retired investment professional and developer of Corequity, an equity valuation service used by institutional investors. These purchases helped increase Yahoo’s earnings per share about 16 percent annually, on average.

But a good bit of that performance was the buyback mirage. Growth in Yahoo’s overall net profits came in at about 11 percent annually.

Given these figures, Mr. Colby reckoned that Yahoo, if it had invested that same amount of money in its operations, would have had to generate only a 3.2 percent after-tax return to produce overall net profit growth of 16 percent annually over those years.

Some companies argue that the money they spend repurchasing stock is a shrewd use of their capital. And given Yahoo’s track record in recent years, its management team seems to have had a hard time identifying profitable investments.

But Mr. Colby pointed out that buybacks provide only a one-time benefit, while smart investments in a company’s operations can generate years of gains.

Yahoo did not reply to an email seeking comment about its buybacks.

This analysis may be of interest to Starboard Value L.P., an activist investor that is a large and unhappy Yahoo shareholder. On Thursday, Starboard nominated nine directors to replace the company’s entire board, saying its current members lack “the leadership, objectivity and perspective needed to make decisions that are in the best interests of shareholders.”

 

In a statement, Yahoo said: “The board’s nominating and governance committee will review Starboard’s proposed director nominees and respond in due course.”

Yahoo is not alone. Mr. Colby conducted a cost-benefit analysis of 26 companies buying back stock versus using that money to invest in a business.

He found that McDonald’s was another problematic example. Since 2008, McDonald’s has allocated almost $18 billion to buybacks. This has helped to produce 4.4 percent increases in annual earnings per share over the period. To equal that growth in overall earnings, the company would have had to generate just a 2.3 percent return on the money it spent buying back stock, Mr. Colby estimated.

Last November, Moody’s Investors Service downgraded McDonald’s unsecured debt rating, citing its plans to increase its borrowings in part to fund future buybacks.

Becca Hary, a McDonald’s spokeswoman, said the company had a “balanced and disciplined capital-allocation strategy that promotes long-term value for our shareholders.” She cited McDonald’s plans to invest $2 billion to open a thousand new restaurants and “to reimage 400 to 500 locations” domestically.

In an interview, Mr. Colby said his research “confirms my suspicion that while buybacks are not universally bad, they are being practiced far more broadly and without as much analysis as there should be.”

Perhaps the crucial flaw in buybacks is that they reward sellers of a company’s stock over its long-term holders. That’s because a company announcing a repurchase program usually sees its stock price pop in the short term. But passive investors, such as index funds, and other long-term holders gain little from the programs.

Especially problematic are buybacks financed with borrowed money; repurchases of stock made at prices above its intrinsic value are also dumb.

Another hazard: companies that spend billions to repurchase stock without substantially shrinking the number of shares outstanding. In these circumstances, prized corporate cash is used to offset stock grants bestowed on company executives in rich compensation plans.

And there are plenty of companies whose buybacks have simply left them with less money to invest in more promising opportunities.

“By throwing away money on buybacks, companies are giving up on the ability to grow in the future,” said Michael Lebowitz, an investment consultant and macrostrategist at 720 Global in Chevy Chase, Md.

At last, some investors are stirring on this issue. Domini Funds, a mutual fund company, and the A.F.L.-C.I.O.’s investment funds have submitted shareholder resolutions on share buybacks at 3M, Illinois Toolworks, Target and Xerox this year.

The proposals ask the companies to adopt a policy of excluding the effect of stock buybacks from any performance metrics they use to determine executive pay packages.

“We’re not against buybacks,” said Adam M. Kanzer, a managing director at Domini. “The question is at what point do buybacks become excessive and when do they undermine the long-term value of the company?”

At 3M, for example, research and development expenditures plus strategic acquisitions have totaled $22 billion over the last five years, Mr. Kanzer said. In the meantime, the company’s buyback program has cost $21 billion.

“When the buyback almost equals all the other expenditures, it makes sense to ask questions about whether there’s a more constructive way to invest that capital,” Mr. Kanzer said.

Asked about these questions, Lori Anderson, a 3M spokeswoman, referred me to the company’s proxy filing, which stated: “We believe these concerns are unfounded, as demonstrated by our long-term track record and our balanced capital-allocation approach.”

A group of institutional investors will also convene soon to examine the pros and cons of buybacks. The Shareholder Forum, which conducts independent programs to provide information that helps investors make sound decisions, is starting a new program on the topic.

“You really have to ask why a company’s board decides to return a big chunk of capital instead of replacing managers with ones who can figure out how to develop the operations,” said Gary Lutin, who oversees the Shareholder Forum.

“If the board doesn’t think it’s worth investing in the company’s future,” Mr. Lutin added, “how can a shareholder justify continuing to hold the stock, or voting for directors who’ve given up?”


 

A version of this article appears in print on March 27, 2016, on page BU1 of the National edition with the headline: Sacrificing The Future For a Mirage.

 


© 2016 The New York Times Company

 

 

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This Forum program is open, free of charge, to anyone concerned with investor interests in the development of marketplace standards for expanded access to information for securities valuation and shareholder voting decisions. As stated in the posted Conditions of Participation, the Forum's purpose is to provide decision-makers with access to information and a free exchange of views on the issues presented in the program's Forum Summary. Each participant is expected to make independent use of information obtained through the Forum, subject to the privacy rights of other participants.  It is a Forum rule that participants will not be identified or quoted without their explicit permission.

This Forum program was initiated to address issues and objectives defined by participants in the 2010 "E-Meetings" program relevant to broad public interests in marketplace practices, rather than investor decisions relating to only a single company. The Forum may therefore invite program support of several companies that can provide both expertise and examples of leadership relating to the issues being addressed.

Inquiries about this Forum program and requests to be included in its distribution list may be addressed to access@shareholderforum.com.

The information provided to Forum participants is intended for their private reference, and permission has not been granted for the republishing of any copyrighted material. The material presented on this web site is the responsibility of Gary Lutin, as chairman of the Shareholder Forum.

Shareholder Forum™ is a trademark owned by The Shareholder Forum, Inc., for the programs conducted since 1999 to support investor access to decision-making information. It should be noted that we have no responsibility for the services that Broadridge Financial Solutions, Inc., introduced for review in the Forum's 2010 "E-Meetings" program and has since been offering with the “Shareholder Forum” name, and we have asked Broadridge to use a different name that does not suggest our support or endorsement.