Stock Buybacks

The Wall Street Journal ran a front page piece today discussing large cap companies' recent trend of busily buying back stock, and that this has been misleading investors as to the actual health of the business.

I confess to have been initially confused by this. Surely nobody seriously focused just on EPS, so that a reduction in equity which would arithmetically boost the ratio is seen as performance improvement? But, I guess the WSJ is, in effect, telling us that most analysts and investors are too inept to spot this.

More to the point, though, who cares about EPS? Growth is found up on the revenue line of the income statement. EPS is such a manufactured concept that I'm surprised, especially post-Enron, that anybody would consider the measure so crucial.

I don't really care much whether companies are buying back their stock or not, ceteris paribas. If they pay too much, I presume that investors will depress the stock's price even more by selling their shares. If it's a wise move, the price and total return should rise. However, it seems to me that the more important issue is whether companies are growing revenue in a consistently superior manner.

Focusing only on balance sheet antics seems to me to be a bit misplaced. My proprietary research has found that, for growth companies, balance sheet structure, per se, is not so important as maintaining revenue growth. If a company has to resort to stock buybacks to manufacture EPS growth, and relies on investors and analysts to not notice, then it's probably already in a bad position.

Certainly, buying back stock does signal that the company hasn't adequate prospects for the capital. Perhaps the shares are priced so that the buybacks are a profitable move for the remaining shareholders.

However, it continues to amaze me that the WSJ can be serious in believing that many analysts and investors rely on EPS data, and would fail to realize whether or not a company is manipulating the measure via stock repurchases.

Looks like I'm not the only one who believes that most analysts and institutional investors constitute a mediocre crowd that mindlessly pushes near-term stock prices around with little understanding of longer-term context.