No, stock buybacks are not a scam

I normally agree with the angry rants posted at lewrockwell.com, so I was surprised at the most recent article entitled Stock Buybacks are a Scam, by Eric Englund. The gist of his argument is summarized thusly: a bunch of large financial institutions underwent major buybacks over the past 6 years*, and now all of their stocks are tanking. Therefore, stock buybacks are bad for shareholders. Stated that way, it sounds stupid, to anyone who remembers that correlation does not necessarily equal causation.

He makes other points, such as that if buybacks are so good for companies, shouldn't management execute them when times are so tough? But of course that would be stupid, because during tough times a company should watch it's balance sheet and hold on to cash for dear life. Therefore, stock buybacks are always evil. This type of paranoid ranting bothers me, because it distracts from more deserving paranoid rants.

When a company earns money, it has 2 basic choices: re-invest to grow the company, or distribute the earnings to shareholders (or maybe employees). In order to distribute the earnings, the company can just pay the money out in cash as a dividend, or repurchase shares to drive up the price and value of remaining outstanding shares. Prior to the Bush tax cuts, the latter choice was clearly optimal because dividends were taxed at a much higher rate than capital gains; nowadays they're usually taxed at the same rate, so the choice is less clear.

The basic idea of a stock buyback is that a company believes its shares are undervalued, and thus shareholder value can be increased by buying shares. The understand this, lets say that the shares were exactly correctly priced at 1 share = present value future earnings. Buying 1 share at $100/share doesn't gain or lose the company anything, it pays $100 for $100 of future earnings. If the shares were undervalued, say at $90, then the company pays $90 for $100 of earnings. Of course, the company is only likely to be undervalued during "tough times", so management needs to make sure they have enough working capital (as always), but any surplus should be invested as profitably as possible.

Seems like a good idea to me. The act of the buyback will drive up the share price, benefiting current shareholders. Englunds argument about weakening the balance sheet is true of any business activity which requires capital, also known as any business activity. Still, buybacks are only a good idea if shares are undervalued, and the capital used could not be reinvested more profitably somewhere else.

Englund closes with a story told by Buffett (how could anybody disagree with Buffett?), about a CEO who uses share buybacks to drive up the share price and hide the declining earnings of the company. This is a valid concern, but Buffett's point relates to executive compensation, and gave an example of a CEO making a killing even though the company's earnings declined, because the CEO drove up the share price through buybacks.

This is an example of how stock buybacks can be used to hide declining performance. Most investors only care about a companys' share price. As long as it goes up, they're happy. A company which spends all of its' earnings on buybacks to drive up the price is not growing, and what investors are losing is opportunity. This is a real cost, and an investor should not be happy about a CEO sacrificing opportunities for long-term growth to create short-term stock gains.

A buyback is intended to transfer earnings from shareholders, and that's exactly what it does. Dividends do the same thing, but I'd be surprised if anybody would call massive dividends a scam. Usually the opposite is claimed, since payout ratios have been decreasing over time. They're ways to return earnings to shareholders. Obviously, management needs to strike a balance between retaining earnings for growth and paying out earnings to shareholders.

Yes, buybacks can be used to cover up declining earnings, and as such, they can be used to mislead shareholders. That doesn't make them bad in general, just like hammers aren't inherently evil because you can use them to kill people. They're a tool, simple as that.

Error rating: 3. The entire argument is based on 7 companies which are going through hell right now, assuming correlation equals causation, generalizing from 7 companies all in a single industry to the entire stock market, and mis-interpreting an example from Buffett. On second thought, all that together adds up to a 4.

-Enginerd

* He gives figures for J.P. Morgan, Citigroup, Lehman, Merill Lynch, Morgan Stanley, Wachovia, and Washington Mutual

Statistically speaking, god must exist

Well apparently I was wrong. The Qur'an logically must be correct, and therefore god must exist:

The Qur’an speaks about hundreds of things that were not known to men at the time of its revelation. Only in three options the result is .0017%. I leave it upto you, to work out the probability if all the hundreds of the unknown facts were guesses, the chances of all of them being correct guesses simultaneously and there being not a single wrong guess. It is beyond human capacity to make all correct guesses without a single mistake, which itself is sufficient to prove to a logical person that the origin of the Qur’an is Divine.

The 3 options mentioned are the Qur'an saying the world in round (known by the ancient greeks, and any sailor who's seen a ship sail over the horizon since the dawn of time), the fact that the moon gives off reflected light (given that you can see the features on it and not the sun or other stars, not too unreasonable), and the most unlikely correct statement, that all life is made of water.

It's difficult for me to point out how obvious it is that life on Earth is based on water. We drink it, we see animals drink it, we bleed liquid, we sweat it, animal meat is moist, corpses look different after they've had a chance to dry out...you'd really have to be a moron not to figure out that water is important.

The main logical error being committed here is assuming that prior to roughly 1700 A.D., people were complete idiots. Eratosthenes figured out the size of the Earth, in fact. The sad fact is that knowledge can be lost after being gained, and just because group of people knows something about the natural world, doesn't mean all of humanity knows it. This is still true, but was more true before books, newspapers, postal services, telephones, and the internet.

The other error is assuming that you need to be able to build an electronic computer, put a camera in a satellite, and snap a photo to figure out the shape of the Earth. You don't. See a ship sail away? The fact that it disappears from the bottom up (instead of to a point) means the Earth couldn't be flat. You can also observe the shadow the Earth casts on the moon during an eclipse. It's always a circle, something only possible if the Earth is a sphere.

Then there is the logical leap that, even given the Qur'an unlikely getting things correct, it must've been written by the creator. It could've easily been written by a more advanced Earthly civilization, or aliens. Or, even if it was written by a god-like entity, that's not proof that praying 5 times a day and stoning adulterers is correct or necessary.

Error rating: 6. Each logical error is slightly understandable, but there are several.

Let the masses rule? Impossible

So apparently some radicals think that the public should decide how best to govern the nation:

The foundation has posted its Transparency in Government Act of 2008 on the Web at publicmarkup.org and has invited the public to tweak, add to or criticize any aspect of the proposed bill. The goal, said Ellen Miller, executive director of the foundation, is to change the backroom, secretive way that legislation is typically passed in Washington.

Now, some people think this is a bad idea:

The idea was not as well received by Paul Miller, past president of the American League of Lobbyists. Miller says lobbyists are unfairly portrayed as backroom-deal makers.

There is more transparency in legislation than ever before, Miller said. But he disagrees with putting bills up for all to rewrite.

"I don't think the way you advocate is to put everything online and say, 'All right American people, weigh in on that,' because then what's next?" Miller asked. "Are we going to let the American people decide our defense policy, our trade policy, our immigration policy?"

I'm just going to assume he was quoted out of context, and meant something more like "Policy decisions require a broad base of knowledge and careful, critical analysis, that members of the public simply do not perform." But still, telling the public that they shouldn't have a voice in government decisions IN A DEMOCRATIC COUNTRY seems just a tad idiotic.

Error Scale: 4 (assuming there was some redeeming context)