Why do buyback announcements fail to boost stock prices?
.
.
Typically if a company has generated surplus cash from its operations and is of the opinion that the cash cannot be profitably redeployed in the business in the near term, it may choose to distribute such cash amongst its investors by way of dividends. Further, if the company has built up a war chest anticipating large capital expenditure and because of adverse market conditions it decides against expansions, then its management may decide in favor of using the cash to mop up equity from stockholders desirous of cashing out. It also sends out signals that in the opinion of the management, the intrinsic value of the business is not adequately reflected in its stock price.
When a company buys back its shares and cancels it, the residual stake held by existing holders goes up. Each residual share gets a larger claim to the earnings pie (the numerator) since the number of shares (denominator) has gone down. As a result there will be fewer claimants to its equity and distributable profits (numerator) in future. Lower investor base brings down annual servicing costs. So even at a time when business prospects are not so buoyant, the surplus resources are not allowed to clog the arteries of business since overcapitalization is more dangerous than under capitalization. The business runs with optimal capital – and no excess flab.
But recently we’ve been noticing consistent decline in stock prices of companies that announce the buyback. Is it that investors don’t read the signals? Or is it that they read it only too well?
Notice the times. Liquidity is hard to come by and managements would do well to keep money in the bank than apply it towards stock buyback. If they need it later, how sure are they of raising it? If sure, at what cost? That is why investors see buyback announcements made by companies as management swagger, not backed by seriousness of purpose with an intention to capture value. Not the least when interest rates are going up and raising debt is way too expensive. Especially if it comes from companies that are already reeling under huge interest burden such as Reliance Infrastructure or DLF Limited that face a double or triple whammy - with large unfunded capex plans, bruised by economic headwinds and wading through a tardy business cycle.
When a company buys back its shares and cancels it, the residual stake held by existing holders goes up. Each residual share gets a larger claim to the earnings pie (the numerator) since the number of shares (denominator) has gone down. As a result there will be fewer claimants to its equity and distributable profits (numerator) in future. Lower investor base brings down annual servicing costs. So even at a time when business prospects are not so buoyant, the surplus resources are not allowed to clog the arteries of business since overcapitalization is more dangerous than under capitalization. The business runs with optimal capital – and no excess flab.
But recently we’ve been noticing consistent decline in stock prices of companies that announce the buyback. Is it that investors don’t read the signals? Or is it that they read it only too well?
Notice the times. Liquidity is hard to come by and managements would do well to keep money in the bank than apply it towards stock buyback. If they need it later, how sure are they of raising it? If sure, at what cost? That is why investors see buyback announcements made by companies as management swagger, not backed by seriousness of purpose with an intention to capture value. Not the least when interest rates are going up and raising debt is way too expensive. Especially if it comes from companies that are already reeling under huge interest burden such as Reliance Infrastructure or DLF Limited that face a double or triple whammy - with large unfunded capex plans, bruised by economic headwinds and wading through a tardy business cycle.
.
No comments:
Post a Comment