It’s perhaps not surprising that US corporations have taken advantage of historically low interest rates by issuing record amounts of debt. It’s revealing, however, that companies are using the proceeds to buy back their shares with stock prices at all-time highs. According to S&P Capital IQ, US firms are repurchasing their shares at a pace not seen since 2007. Together with the recent surge in M&A activity, this suggests that companies’ organic growth opportunities are scant. Goosing earnings per share via acts of financial engineering (like debt-financed share buybacks) is not a viable long-term strategy. In Berkshire Hathaway’s 2011 shareholder letter, Warren Buffett wrote:
It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation — whether the money is slated for acquisitions or share repurchases — is that what is smart at one price is dumb at another.
With valuations looking increasingly stretched, we suspect companies will have to demonstrate real growth for stocks to move measurably higher. A shift in priorities also seems in order. In “The Price of Wall Street’s Power,” Gautam Mukunda argues that prudent decision making by company management is too often undermined by Wall Street’s “outsize influence” and obsession with meeting short-term financial targets. What’s the remedy? In “Curbing Short-Termism in Corporate America: Focus on Executive Compensation,” Robert Pozen calls for longer time horizons in management incentive packages and an end to quarterly earnings projections.
Below are some other stories and videos that caught my eye in recent weeks.
- Value investor Steven Romick says bargains are few and far between. (WealthTrack, video)
- “Contrarian” Chronicles Life and Legacy of Sir John Templeton (Enterprising Investor)
- The latest issue of the EVALUATION newsletter includes interviews with Marc Lasry and Edward Altman. (NYU Stern, PDF)
- A call to ignore profit margins and focus on ROEs instead. (Philosophical Economics)
- David Rosenberg on what Mr. Bond is telling the market. (Financial Post)
- “QE and the Japanese Stock Market” (Financial Times)
Buffett and Big Blue
- Jeff Matthews on succession at Berkshire Hathaway. (Jeff Matthews Is Not Making This Up)
- “The Trouble with IBM” (Bloomberg Businessweek)
- The gamblers’ fallacy creates hot hand effects in online gambling. (Cognition)
- How we overestimate our prediction abilities. (Alpha Architect)
- Bethany McLean on how corporate jets fly under shareholder radar. (Reuters)
- “‘Optimal Disclosure’: Why Firms Need to Balance ‘Hard’ and ‘Soft’ Information” (Knowledge@Wharton)
- Betting big on the future of smoking. (Forbes)
- A useful primer: The Tobacco Industry. (CFA Institute)
The Lighter Side
- Goldman Sachs present “The World Cup and Economics 2014.” (Goldman Sachs)
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
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