Title: Are Stock Buybacks a good sign
1- Are Stock Buybacks a good sign
- Stock Buybacks Good or Bad
- Author Hari Swaminathan
2(No Transcript)
3About OptionTiger
- Over the last few years, weve heard a lot about
stock buybacks, and in fact, stock buybacks are
at historically high levels. Many US companies,
holding large amounts of cash are putting it to
use by buying back their own stock. - But what exactly does Stock buybacks tell us,
and are they a good sign or bad ? There are
several interpretations and it could mean one or
more of the following
1) Generally, companies would (should) prefer to
deploy cash into additional revenue streams. This
could be opening new factories, new products,
invest in RD, or building new businesses. These
activities, over the long run, will produce a
higher return on capital than if the money was
just being held as cash. By using this cash
instead to buy back its own shares, perhaps is a
sign that these companies dont feel confident of
building additional revenue streams, at least in
the prevailing environment.
4About OptionTiger
- 2) Stock buybacks can also mean a company is
having serious issues with growth, specifically,
growing the bottomline. As we all know, companies
are valued in the public markets based on several
parameters, but the chief ones are earnings, and
earnings growth. The exact metric is EPS
(Earnings per share). If a company has an EPS of
3/share, and the next year, they produce an EPS
of 5/share, this is great. It shows that the
company is growing nicely, right ? Well, this is
the problem. Many companies use the
stock buyback trick to mask poor earnings
performance. When a company buys back stock from
the market, there are fewer shares in
circulation. As a simple example, if there were
100 shares in the public float before a buyback,
and a company buys back 25 shares, then there are
only 75 shares in circulation. The EPS
calculation now is much higher, and gives a false
perception of growth or the health of the
company. - 3) Companies can be genuinely concerned about
market conditions and/or their own stock price.
If they feel their stock is undervalued, for
whatever reason, it may be a good time to buy
back some shares. And when the market eventually
prices its shares according to what it deems to
be a fair valuation, the company can make good
profits by selling it back at that time. There is
nothing wrong with this move. Its just taking
advantage of temporary situations in the markets.
The key indicator is to see how much was the
buyback relative to their other normal business
investments for the year.
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- - How does the amount of stock buybacks compare
to say, their usual investments into new products
or RD. If a company normally (average last few
years) invests 100M into RD, and this year they
invested only 20M but were involved in a large
stock buyback, that does not sound good. -
- Whatever the reasons are, retail investors
should make sure it passes the smell test. A
quick review of the financial statement should
clearly reveal the nature and amount of buybacks,
the reasons the company gives for these buybacks,
and your own investigation into the numbers
should reveal the true picture. If it smells
fishy, then it probably isNot every
Stock buyback is to be interpreted as negative,
although a majority are in some respect or the
other.
6About OptionTiger
- As we can see, there are some good reasons to
buy back your own Stock, and there are some
reasons that are not. So how can a retail
investor figure out which one is it ? Well, if
youre a fundamental investor, you must be
familiar with poring through financial
statements. This is the basis of your investment
philosophy. There is plenty of information you
can glean from financial statements. For
example, -
- - How was revenue growth and compare that to EPS
growth ? If you see strange numbers like revenue
increased by 5 but earnings increased by 20,
that does not sound right. Youll need to look
for reasons why this happened. There may be a
genuine reason like a major cost cutting
initiative that panned out very well. But
whatever the reasons are, its important to
understand them.
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