Post by
Walter333 on Jan 25, 2022 10:42am
May need to repost this for David MilMan
Unsure if David simply didn't read it last time posted, or if he did but simply didn't comprehend it. FSD Pharma Share Buyback: Buybacks can boost EPS. When a company goes into the market to buy up its own stock, it decreases the outstanding share count. This means earnings are distributed among fewer shares, raising earnings per share. As a result, many investors applaud a share buyback because they see increasing EPS as a surefire approach to raising share value. But don't be fooled. Contrary to popular wisdom (and, in many cases, the wisdom of company boards), increasing EPS doesn't increase fundamental value. Companies have to spend cash to purchase the shares; investors, in turn, adjust their valuations to reflect the reductions in both cash and shares. The result, sooner or later, is a canceling out of any earnings-per-share impact. In other words, lower cash earnings divided between fewer shares will produce no net change to earnings per share. Of course, plenty of excitement gets generated by the announcement of a major buyback as the prospect of even a short-lived EPS rise can give share prices a pop-up. But unless the buyback is wise, the only gains go to those investors who sell their shares on the news. There is little benefit for long-term shareholders. To Benefit Executives Many executives get the bulk of their compensation in the form of stock options. As a result, buybacks can serve a goal: as stock options are exercised, buyback programs absorb the excess stock and offset the dilution of existing share values and any potential reduction in earnings per share. By mopping up extra stock and keeping EPS up, buybacks are a convenient way for executives to maximize their own wealth. It's a way for them to maintain the value of the shares and share options. Some executives may even be tempted to pursue share buybacks to boost the share price in the short term and then sell their shares. What's more, the big bonuses that CEOs get are often linked to share price gains and increased earnings per share, so they have an incentive to pursue buybacks even when there are better ways to spend the cash or when the shares are overvalued. Buybacks Using Borrowed Money For executives, the temptation to use debt to finance earnings-boosting share purchases can be hard to resist, too. The company might believe that the cash flow it uses to pay off debt will continue to grow, bringing shareholder funds back into line with borrowings in due course. If they're right, they'll look smart. If they're wrong, investors will get hurt. Managers, moreover, have a tendency to assume that their companies' shares are undervalued regardless of the price. When done with borrowing, share buybacks can hurt credit ratings, since they drain cash reserves that can serve as a cushion if times get tough. One of the reasons given for taking on increased debt to fund a share buyback is that it is more efficient because interest on the debt is tax deductible, unlike dividends. However, debt has to be repaid at some time. Remember, what gets a company into financial difficulties is not lack of profits, but lack of cash. To Fend Off an Acquirer In some cases, a leveraged buyback can be used as a means to fend off a hostile bidder. The company takes on significant additional debt to repurchase stocks through a buyback program. Such leveraged buybacks can be successful in thwarting hostile bids by both raising the share value (hopefully) and adding a great deal of unwanted debt to the company's balance sheet. To Get Rid of Cash It's very hard to imagine a scenario where buybacks are a good idea, except if the buybacks are undertaken when the company feels its share price is far too low. But, then again, if the company is correct and its shares are undervalued, they will probably recover anyway. So, companies that buy back shares are, in effect, admitting that they cannot invest their spare cash flow effectively. Even the most generous buyback program is worth little for shareholders if it is done in the midst of poor financial performance, a difficult business environment, or a decline in the company's profitability. By giving EPS a temporary lift, share buybacks can soften the blow, but they can't reverse things when a company is in trouble. The Bottom Line As investors, we should look more closely at share buybacks. Look in the financial reports for details. See whether the stock is being awarded to employees and whether repurchased shares are being bought when the shares are a good price. A company buying back overvalued stock especially with lots of debt is destroying shareholder value. Share repurchase plans aren't always bad, but they can be. So be careful out there.