Why is it bad when a company buys-back its own stock? They become ZOMBIES, The "Walking Dead" of Wall Street
So, why is it bad when a company buys back its own stock? Here's the answer: EPS is a measure of company performance. It is calculated:
Net Income / Shares Outstanding
Stock prices tend to go up when a positive earnings per share (EPS) is announced, and down when negative EPS is announced. CEOs and CFOs know this and will do everything they can to "windowdress", especially to disguise a bad year or quarter.
When a company buys its own stock it reduces the number of shares outstanding and increases EPS even though the company made no additional net income. This is how a company can lose money and still have a growing EPS. They will tell you they are doing it as a way to reward the shareholders, which is true as long as the company is cash rich like Intel or Apple, but most companies are borrowing money to finance stock buy-backs, and they are doing it at a time when shares are selling at their highest multiple in years. These companies are referred to as Zombies, they are the walking dead. I did not make this term up. Read more about the rise of the Zombie firm here.
What does this mean if you're an investor?
It means you need to focus on companies with earnings, not earnings per share. If a company isn't making a profit (read: net income goes down), but the EPS is still going up, it's a red flag because this can only happen one way -- if the company bought back shares. It's a super red flag if debt is going up at the same time and the company is using the debt to purchase shares (read: shares outstanding is going down). You don't want to own these companies. These are great short opportunities.
What does this mean if you're a consumer?
It means companies will be competing for your dollar more than ever. These are hard times for local retailers who must compete against online retailers as well. They also don't have our undivided attention like they did 20 years ago. Which is to say the new entertainment model (Netflix, Amazon Prime, etc) allows most of us to opt-out of watching commercials. Now, retailers are looking for ways to get back in your head. Enter rewards or cash back programs. These programs have become better at reaching a wider audience than a traditional ad or commercial. Not only has the number of programs increased, but the percentage of cash going back to the customer is growing. This will come back to the retailer in one of two ways: 1) it will grow foot traffic at the expense of pricing or 2) it will create write-offs. Write-offs can be pushed to the next quarter or year and they allow a company to drastically reduce prices in the current quarter. Either way, look forward to heavy discounts this holiday season to increase foot traffic.
Posted by Celan Bryant
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