In response to an FT article by Ed Luce on 26th April 2015, entitled 'US share buybacks loot the future'
Very good Mr Luce.
I would make one addition. As well as saying: "The future of the US economy would look brighter if its chief executives were listening" I would add:
"The future of the US economy would look brighter if the Federal Reserve were listening".
This is not news to them. They have been repeatedly warned about this by commentators, business people, traders and yes, even some economists, for at least the past three years. They have ignored these warnings.
So, they either:
a) Haven't got the foggiest idea how economies and markets work, or
b) See the long term destruction of wealth generation capability as a price worth paying in pursuit of the sacred cow of 'aggregate demand'...even though it became obvious that the aforementioned cow left the farm years ago because they weren't feeding her properly, or
c) Both
My money is on c)
***
A fellow reader replied:
There is a reason why CEOs love share buy-backs. One of their key performance indicators is the EPS ratio. For the same earnings, EPS increases if there are fewer shares in float. And if EPS increases, then the CEO gets rewarded handsomely with a huge bonus. That's why company boards prefer buying back shares instead of, say, returning the same money to investors through dividends. Another favorite tool of the CEO is to increase the EPS by inflating the earnings by acquiring another company.
But there is an inane message that a share buy-back sends out to a growth investor. It tells the investor that the CEO, or his company, does not know what to do with the money in order to grow the company organically. So it tells us that the company lacks imagination in increasing its market share or in creating new markets through innovation.
MarkGB:
Well said.
In some cases it's even worse:
Many companies are not just spending accrued cash, they are spending new debt. I.E. They are borrowing at ZIRP, retiring shares which would pay dividends at 3%, thus boosting the EPS and everyone's bonus, exactly as you say. But now it's even worse because apart from the detrimental effect on capital investment, all that new debt will also have the long term effect of trashing the balance sheet.
Of course the 'algos' love this, since QE/ZIRP has made this process into a predictable, self-fulfilling prophecy. Thus, since Price is rising faster than Earnings (and much faster than Sales), we currently have a CAPE of 27, roughly equal to 1929 and 2007, and second only to 2000. When we have the next bear market, which we will despite the best efforts of the Fed, the 'algos' will love that too - and the whole sad process will reverse.
The CEOs are the ones imbibing the monetary dope, but the pushers are those wonderful people down at the Fed, curtesy of their magic money tree.