Tuesday, February 27, 2018

Stock Buybacks - Another Sign of the End Times?

Trump's corporate tax cut didn't result in "investment" in America, but rather stock buy-backs that benefit a few wealthy people.  Stock buy-backs are like a snake eating its own tail.

The results are trickling in, and it turns out that the "benefit" of the Corporate tax cut is largely limited to major shareholders of corporate stocks, as well as corporate leaders who are paid in stock options.   Companies are buying-back shares to bolster share price.

I noted before that companies can "pay" shareholders in a number of ways, and one way is in buying back shares of stock - something that before 1980 was considered "manipulation" of share prices.  But the SEC ruled it was legal, and since dividends are taxed at higher rates than capital gains, many companies chose to buy back their own stock shares, rather than issue dividends.

The net result is share prices are higher, which means you have made money (on paper) but until you sell those shares, you have no taxable event.   And when you do sell, the gains are long-term capital gains, often taxed at 15%.   Pretty sweet deal if you are wealthy - and want to stay that way.

But as I noted before, a company buying-back its shares may be headed for trouble. They are not "investing" in their company, but rather taking money out of it - and concentrating more on making money for the CEO than anyone else.   And the effects on share price may be short-lived.

If a company isn't making money, cutting the number of shares isn't solving much of anything.  Moreover, many share buy-backs are in effect doing what every financial adviser says not to do - buying high, selling low - the one-way ticket to bankruptcy court.

When a company even hints it may buy back shares, as Warren Buffet did recently with regard to Berkshire-Hathaway, share prices skyrocket.  Since in most cases, share buy-backs occur when the company is flush with cash, the share prices are at all-time highs.   The cost of the buy-back is thus huge.   The company after buying back its shares, has less cash on hand and arguably is worth less than before.

When the company needs capital to build a new factory or make other improvements, they either have to sell bonds and take on debt - or issue new shares of stock.   And they are often doing this when the share price is in the toilet.   So it is classic Buy high, sell low when it comes to share buybacks and issuing new shares.

The image above is of the Ouroboro - an image used by alchemists of a snake eating its own tail.   In  a way, stock buy-backs are the same idea.  The company will eat more and more of its own tail until there is nothing left but the head - maybe the CEO with his remaining shares.  Or maybe the whole thing vanishes.   And the idea of the stock buy-back is a little like alchemy - which is one reason the SEC outlawed it in the first place.

Of course, many predicted before the corporate tax cut that this is exactly what would happen.  The fantasy that companies would use the money to build new factories was the delusion of a failed businessman who never owned or ran a factory.   If you are manufacturing cars, you don't need a new factory - auto production capacity is already way beyond world demand.   And you aren't about to move small car production from Mexico, China, Korea, or wherever, to the USA, as you would lose money on each car you made - due to the higher labor and overhead costs here.   So there is really not much you can do with this money, except perhaps finally fund that underfunded pension liability for your workers.

HA-HA!  Of course, you don't do that.  The guy at the money switch, making the decisions, is the CEO, the CFO, the COO, and the Board of Directors - all paid in stock options, and all making a lot of money if the share price can spike, even for a few months or so.   So guess what they decide to do?

You have been paying attention after all!

We went through a similar tax holiday - one-time only - in 2005 under the Bush Administration.   Companies then bought back stock, much as they did today, with their repatriated cash.   2005 was good times.  Housing prices were through the roof, and the stock market was going well.   We were winning the war on terror.   Ahhh... Good Times!   And then something happened a year or two later but I can't remember what - can you?

The problem for our economy is that even if companies built these factories with their tax cut dollars, no one would be able to buy the products.   Consumers are over-spent as it is, and cannot take on any new debts.   Overseas customers are not going to take up the slack, due to the strong dollar and reciprocal trade tariffs.  In a way, buying-back your own stock is the most logical thing to do, as you really can't do much else with the money.  "Investing" in America isn't going to make you more profits, so you might as well keep the cash.