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.
This post was published at David Stockmans Contra Corner on March 31, 2016.