Share Buybacks vs Insider Buying

Good article in The New York Times: "Stock Buybacks Demystified".

Some snippets:


Corporate insiders have impeccable timing when buying stock for their own accounts. When the ratio of insider buying to selling is higher than normal at many companies at the same time, it tends to be near a market low.

That was the case in late 2008 and early 2009, toward the end of the last bear market. The ratio was at historically high levels for months, just before stocks tripled, according to Vickers Weekly Insider, a service that tracks such trading.

But when bosses authorize buybacks — buying stock on behalf of their companies, not themselves — they show nothing like the same foresight. The $617 billion that companies in the Standard & Poor’s 500-stock index spent on buybacks in the 12 months through January 2008 was the highest amount in the nine years for which the research firm FactSet has compiled such data.

That was just in time for the worst market decline since the 1930s. The following year, a more auspicious time to accumulate stocks, buybacks totaled $353 billion.

“Insiders, when buying for themselves, are not looking at the present; they’re looking at the future. Buybacks are done for the present; cash flow is high, so they use it for buybacks. That drives them in good times and bad.”

Buybacks tend to be done late in an uptrend because that’s when there are fewer attractive alternatives for spending money and the greatest need to lift earnings. But that’s also when stock valuations are high. If companies borrow to accomplish their buybacks, as many do, it leaves them even worse off when the cycle turns down because they have more debt on their books, he added.


I have never been much of a fan of share buyback programs. I have seen enough cases in which these programs were abused, for instance :

• A share price was "defended" at some artificial price level. When the money for the share buyback program ran out the share price crashed, not unexpectedly. The company should have let the share price go down, enabling it to buy more shares at a cheaper price, for the advantage of all remaining shareholders.
• An aggressive share buyback program exactly at the moment that insiders are selling the share. There is the perception that the share price is artificially supported, enabling insiders to receive a higher price than they otherwise would have.

Share buybacks have been invented in the US, having had a double taxation on dividends.

Asian countries don't have this double taxation, so they can freely distribute excess cash in the form of dividends. There is here actually not much need for share buybacks (with this being a possible exception).

I prefer dividends over share buybacks:

• Dividends are much more transparent, an overview of the dividends paid out in (say) the last ten years is quite insightful in evaluating a company.
• Share buybacks are distracting, both for the management which has to execute it (dealing on a daily basis with price and volume), and for the shareholders who have to evaluate it in combination with the dividends.

AirAsia's dividends: generous but appropriate?

AirAsia published its 4th quarter results. The (in general good) results over the whole year were boosted by a one-off profit from listing their company in Thailand in a previous quarter, no surprise there.

Most remarkably was the large dividend payment, as described by The Star:

"It has also declared a special dividend of 18 sen, on top of a final dividend of 6 sen, which will bring the full-year dividend per share (DPS) to 24 sen. This translates to a DPS yield of 8.4% at RM2.86."

There are two very large financial concerns (next to increased competition from Malindo) regarding AirAsia, their debt and their capital commitments:

 

 

Total Debt stands at RM 8.4 Billion (and increasing) while Capital Commitments are almost RM 65 Billion (also increasing), and the company is paying out rich dividends?

If the company fails (due to the heavy debt burden and/or the capital commitments), the company might be deemed to be "too big to fail" by the government.

And that means that (as usual) the taxpayers are on the hook, to save the company.

Considering that, is the new, generous, dividend policy really appropriate? Should it not preserve cash to ensure it can meet its financial obligations?

Dividends or Share Buybacks?

When companies have excess cash, they should distribute this to the shareholders. For this, they can:

• either pay the money in dividends 
• or buy back their own company shares and subsequently cancel the shares, increasing the earnings and assets of the remaining shares

My clear preference is dividends, I have yet to meet an investor who complained about having received too high dividends.There is only one catch, some investors don't like it when the dividend is cut, so if companies want to pay dividends and know that part of that is due to a one-off event (for instance an asset sale that brought in a huge profit), they could declare part of it as "special" dividend, indicating that it might not be repeated in the future. A clear dividend policy towards the investors would also help in this matter. Another advantage is that dividends are very easy to track, even years in the future one can look back and check how much has been paid in the past. 

Issues surrounding share buybacks:

• Share buybacks only make sense if the share is undervalued, but value is in the eye of the beholder. This issue doesn't play a role for dividends.
• Buybacks must be monitored, the company should make sure that they don't buy more shares than say 20% of the volume done that day. Thus, it can easily distract the management of the company, they should better be focused on their own business instead of monitoring buybacks.
• I have seen companies "defending" their share by massively buying stock at a certain price, after they exhausted their money, the share tanked and the company even lost money on paper.
• I have also seen examples where the company bought large amounts of shares exactly when the CEO sold his private shares. 

All in all, I would strongly prefer dividends over share buybacks, it is more easy, more transparent and can not be abused. Only if the share buyback is executed correctly, the positive effects might be similar to the effects of dividends.

The only company that might use buybacks actively is a closed-end fund: when the share is trading below its Net Asset Value, it could buy some shares and keep them in Treasury. When the share is trading above its Net Asset Value, it could slowly sell some of its Treasury shares.That way it could ensure that the gap between the share price and the Net Asset Value per share is not too large.