Looking Dumber by the Day — Corporate Share Buybacks

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This most recent share buyback binge was dumb money on steroids, with artificially low interest rates leading corporations to borrow big and buy back their stock on the twin assumptions that: 

1) since the cost to borrow was less than their stock dividend, they were generating “free cash flow” and 

2) buying their own stock forced up the price, which would make the CEO look smart. 

Both assumptions were only valid while the market was rising. And since most of the buying took place late in a bull market, with share prices at or near record highs, it was only a matter of time before a correction or (more recently) an actual bear market turned that free cash flow into a monumental capital loss and made that smart CEO look not just dumb but criminally negligent.

It gets even better:

Now much of the cash that the company “returned” to shareholders has become money that the company lost for shareholders. And – here’s where the macro part of the dumb money story begins – the fact that corporate America has leveraged itself to the hilt to buy back stock leaves hundreds of companies in varying degrees of dire financial straits. In other words, with sales growth slowing and free cash flow evaporating, these over-leveraged companies will have to raise capital to shore up their balance sheets. But interest rates are up, which makes new borrowing a massively cash flow negative proposition. Asset sales, meanwhile, become “fire sales” in a downturn (note the above GE example), so that’s a painful and embarrassing option. What’s left? Why, equity sales, of course.

So – as usually happens at the end of long credit parties – the same companies that bought back their shares so aggressively at ever-higher prices now have to pull those same shares out of storage and sell them at ever-lower prices, creating a mini death spiral in which a rising share count pushes down the share price, necessitating more equity sales, and so on.

The full story.