Stock Market Rules: Good Companies Buy Their Own Stock
moneyrelations :: Jan.25.2008
Visitors of this blog know that I try to be informed and I read a lot. However, I am also jaded by what I read. Frankly, I question if people are getting lazy in the “financial porn” industry. It’s the same sales copy over and over again. The problem is that there are lots of expectations out there. There are investing rules that you should abide by because… actually, I have no idea.
Seriously, who made these rules and why should I care?
I am currently reading a book called “Stock Market Rules: 50 of the Most Widely Held Investment Axioms Explained, Examined, and Exposed” by Michael Sheimo.
It sounds promising enough and I have always liked myth busters. Throughout the course of the next few weeks, I will present the chapters that I find interesting so you can decide for yourself whether these “rules” are meant to be broken.
Good Companies Buy Their Own Stock
I must admit that I did believe this axiom. After all it’s a positive news event. Company buybacks increase earnings per share since there are now fewer shares outstanding; it shows confidence that the company has in itself; the company believes that its stock is undervalued. All good, right?
Like anything else, you have to dig a little deeper. Is the announcement of a buyback to offset bad news? Is the stock truly undervalued or are some companies dumb enough to buy back shares at a premium? And yes, they can be. Read this Fortune article on how companies Buy high, sell low. Finally, if the share price is so undervalued, why isn’t the company using the excess cash for growth?
These are all very good points that I personally never thought about because I followed the standard “rules” without question. So next time you buy shares of a company because of the positive implications of a company buyback, give it some extra thought and research.
Investing ::
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Good point.. I believe it was Buffett who said that a company should only buy back its own shares if the return on capital of buying those shares is higher than the return on capital of investing those shares somewhere else or its own business for growth.. Unfortunately, this has been largely forgotten and, whether thru shareholder pressure or otherwise, more and more companies buy overpriced stock.. especially these days when the average P/E ratio is 17 on the S&P500..
Unlike most teenagers I actually enjoy the business world and am intrigued by it. This is an interesting point you make that makes sense and I will definitely have to think about that.
Hey Adil,
It’s a tough choice… how to find innovation and growth without diworsifying into a different market. And you’re right, it was Buffett who said that and perhaps the companies are taking this easy way out to avoid tough decisions?
Hi Selene!
You made my day! Awesome that you’re starting young! I am lucky that I come from a financially responsible family that made me save and invest very early. But now I’m beginning to question the rules and I’d encourage you to do the same. As you can read from this post, always question what is fed to the masses – if you can turn this into your favor, you’re way ahead of the game. Good luck to you!
Good advice thanks, It’s interesting to see all the ways one researches a company. I admit I need to learn a lot more about the aspects of researching and not to invest on a “hunch” or feeling like I seem to do
Damn Etrade.
BTW do you know anything about TradeKing.com? They claim to have $4.95 trades with no account minimum. I’m using ShareBuilder right now but $5 trades sound good.
Nice article buying back shares is a sign of a company that believe in Itself. In most cases that is a good time to buy.
Hi Chris,
Yeah, I know… hunches suck with investing
I learned my lesson with penny stocks… Unfortunately, no, don’t know anything about TradeKing. I don’t know if it’s available for Canada? I’m happy with investing with the brokerage arm of my bank. Just makes things so much easier to administer and less of a headache. I pay $7 so not bad to have everything consolidated. I absolutely hate paperwork.
Hi John,
Thanks for dropping by. I think what I’m learning from the book is just question things more on things you would never think to question. Company buyback a good strategy for some companies but not for others. It’s not a given that it’s the right thing to do for shareholders’ value.