Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Dow Stock Market Trend Analysis - 25th Nov 20
Amazon Black Friday Dell 32 Inch S3220DGF VA Curved Screen Gaming Monitor Bargain Deal! - 25th Nov 20
Biden the Silver Bull - 25th Nov 20
Inflation Warning to the Fed: Be Careful What You Wish For - 25th Nov 20
Financial Stocks Sector ETF Shows Unique Island Setup – What Next? - 25th Nov 20
Herd Immunity or Herd Insolvency: Which Will Affect Gold More? - 25th Nov 20
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20
THE STOCK MARKET BIG PICTURE - Video - 19th Nov 20
Reasons why Bitcoin is Treading at it's Highest Level Since 2017 and a Warning - 19th Nov 20
Media Celebrates after Trump’s Pro-Gold Fed Nominee Gets Blocked - 19th Nov 20
DJIA Short-term Stock Market Technical Trend Analysis - 19th Nov 20
Demoncracy Ushers in the Flu World Order How to Survive and Profit From What Is Coming - 19th Nov 20
US Bond Market: "When Investors Should Worry" - 18th Nov 20
Gold Remains the Best Pandemic Insurance - 18th Nov 20
GPU Fan Not Spinning FIX - How to Easily Extend the Life of Your Gaming PC System - 18th Nov 20
Dow Jones E-Mini Futures Tag 30k Twice – Setting Up Stock Market Double Top - 18th Nov 20
Edge Computing Is Leading the Next Great Tech Revolution - 18th Nov 20
This Chart Signals When Gold Stocks Will Explode - 17th Nov 20
Gold Price Momentous ally From 2000 Compared To SPY Stock Market and Nasdaq - 17th Nov 20
Creating Marketing Campaigns Using the Freedom of Information Act - 17th Nov 20
ILLEGITIMATE PRESIDENT - 17th Nov 20
Stock Market Uptrend in Process - 17th Nov 20
How My Friend Made $128,000 Investing in Stocks Without Knowing It - 16th Nov 20
Free-spending Biden and/or continued Fed stimulus will hike Gold prices - 16th Nov 20
Top Cheap Budgie Toys - Every Budgie Owner Should Have These Safe Bird Toys! - 16th Nov 20
Line Up For Your Jab to get your Covaids Freedom Pass and a 5% Work From Home Tax - 16th Nov 20
You May Have Overlooked These “Sleeper” Precious Metals - 16th Nov 20
Demystifying interesting facts about online Casinos - 16th Nov 20
What's Ahead for the Gold Market? - 15th Nov 20
Gold’s Momentous Rally From 2000 Compared To Stock Market SPY & QQQ - 15th Nov 20
Overclockers UK Quality of Custom Gaming System Build - OEM Windows Sticker? - 15th Nov 20
UK GCSE Exams 2021 CANCELLED! Grades Based on Mock Exams and Teacher Assessments - 15th Nov 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Share Buybacks are Dangerous for Your Dividend Stocks

Companies / Dividends Aug 14, 2012 - 11:34 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleMartin Hutchinson writes: Many investment advisers like to recommend stocks with large buyback programs. A buyback, they argue, is like some sort of magical panacea.

It allows companies to invest in themselves which pushes the share price higher.

On the face of it, the premise seems logical enough. But the reality is that it's not quite that simple.


In fact, you can call me old-fashioned if you like but I believe large buyback programs can actually be dangerous and stocks with them should be avoided. I'll tell you why.

It primarily has to do with the rise of corporate options schemes as form of compensation.

Of course, it wasn't always this way.

Before "options as compensation" became so widespread, management usually owned shares directly just like any other shareholder. It meant they were just as interested in receiving their dividends as the guy on the street.

That has all changed. Now that management has ownership largely in the form of stock options, they're not as keen on dividends. As option holders they don't receive them.

They also recognize dividend payouts cause the share price to fall after they are paid, lessening the value of their all-important options.

It's all about the money you see which is why options-rewarded management came up with share buybacks in the first place.

For options-rewarded management, buybacks have two advantages.

First, they reduce the number of shares outstanding, thus increasing earnings per share and the value of the remaining shares.

Second, if management has a lengthy list of options and wants to exercise them, the share buyback scheme counterbalances the move since the company's earnings per share won't be diluted and its perceived growth rate will stay the same.

It's a sneaky way management uses the shareholders' money in a clever shell game.

The Larger Problem with Share Buyback Schemes
But if that was the only problem, share buybacks would be only moderately damaging.

Certainly, they would still be unattractive to individual shareholders, because most buyback programs are carried out by direct negotiation with large institutions, cutting out small shareholders.

However, the other problem with buybacks is the effect of the business cycle.

Like most economists, corporate management types are usually quite poor at spotting key turning points in the business cycle.

Hence, when business is booming and cash flow is good, management uses the excess cash flow to increase share repurchases. It only follows that they do so at prices near the top of the market.

The problem comes when the market turns. As the downturn inevitably ensues it leaves the company short of cash which means the company has to stop repurchasing shares. This makes buyback schemes pro-cyclical.

The buybacks push up share price even further in good times and are then suspended in bad times, allowing the share price to fall further than it would ordinarily.

Indeed, sometimes the company is actually forced to carry out an emergency share issue at the bottom of the market which effectively robs existing shareholders because the management is forced to buy high and sell low.

You don't need to be a seasoned investor to recognize the problem with this strategy.

The Tug of War Between Buybacks and Dividends
Finally, there is the effect of share buybacks on cash dividends.

For reasons described above, management is much keener on share buybacks than on cash dividends, so they tend to substitute one for the other.

Or, if shareholders insist on a cash dividend, they carry out share buybacks as well, often paying out more than 100% of their earnings.

Either way, the cash dividend is in much more danger with a company that repurchases shares than with one that does not.

Here's why.

When hard times inevitably arise, a company that pays out only 30-50% of its earnings in a cash dividend is generally able to maintain the dividend, but if it has been paying out 80-120% of its earnings in dividends and share buybacks, it is generally forced to suspend both the buybacks and the dividend.

Further, once the dividend has been suspended, it is generally resumed only at a much lower level.

The point is share buybacks only endanger dividends. We saw this at work in the banking industry with the 2008 crash.

For example, before the crash BB&T Corporation (NYSE: BBT), a generally well-run outfit was both paying a quarterly cash dividend of 46 cents/share and buying back stock.

After the market turned down in 2009, BB&T stopped buying back stock, abandoned the dividend, and issued new stock at a much lower price than had existed before the crash.

Now the dividend has been resumed, but at a quarterly rate of 20 cents per share. The blessing is that BBT has now stopped buying back stock and instead plans to raise the dividend.

Other banks, such as JPMorgan Chase (NYSE: JPM) have followed the same pattern, with the dividend being abandoned and then resumed at a much lower rate.

However, in this case JPM has also resumed share buybacks. Don't fall for it.

No matter what you financial advisor may tell you, there is more to share buy backs than meets the eye.

Source :http://moneymorning.com/2012/08/14/dont-fall-for-this-magical-panacea-share-buybacks-are-dangerous-to-your-dividends/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules