The Wall Street Journal reports (subscription required) that 2007 was a record year for share buybacks, especially among financial companies. With the market down, a lot of those repurchases aren't looking so smart. The Journal adds that "the buyback boom looks to be in its final innings. In the fourth quarter last year, buybacks fell 18% from the previous quarter, the biggest quarter-to-quarter drop in more than five years."Making it worse, many of those companies that bought back stock aggressively are now issuing more stock to shore up their balance sheets, and those offerings are being priced at beaten-down valuations. Companies have essentially bought back stock at $100, then sold it at $50, and paid a bunch of fees in the process. Not a good business model.
But let's not throw the baby out with the bath water. Because of the unfavorable tax treatment of dividends, I would argue that share buybacks are the best way for companies to invest excess cash when opportunities to achieve high returns reinvesting in the business are not available. If you're long a stock, presumably you think it's undervalued -- so why would you want to have the company send you cash to pay taxes on, rather than giving you a larger chunk of the business?
The problem is that many buybacks seem to have been done for the purpose of propping up the share price while insiders dumped. But that's a separate issue.
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