In the news of late is the idea put forth by a few Congressmen to put a limit on how much stock a company can buyback. In essence, these politicians feel it is unjust for the management(s) of these companies to spend money on stock and should rather be utilizing their capital on hiring more people, spending it in the economy, etc., even if it’s not needed. Essentially, they don’t believe these executives know what they are doing or more to the point… they don’t know how to manage capital!?!?! Quite frankly, without good capital management your company will cease to exist at some point. And on the other side of the coin, great capital management can take a company far into the future!
For those unfamiliar with the term, a buyback is when a company goes out into the stock market and spends the company’s money on its own stock with the purpose of retiring the shares of stock purchased. The net effect of this transaction is fewer available shares thus increasing the ownership percentage of the remaining shareholders. Sounds like a good concept, especially for a management team doing what is in the best interests of its shareholders (i.e., owners), no?
Needless to say, shareholders want management to do what’s in their best interests. And at the top of the list (maybe the only thing on the list) is do what’s best with the cash (i.e., capital) that the company creates. What’s “best” for the company and subsequently the shareholders, changes based on the current state of the enterprise, economic forecast, etc. This is where management earns it’s “keep”… by properly disbursing their capital.
Your typically company experiences many stages of growth. At first, they are in hyper growth mode and reinvesting every penny they make (i.e., cash) back into their business. And in the case where additional capital is needed, they will bring on debt. The next stage is moderate growth for most companies. At this point they are likely creating more cash than the business needs. Management’s ability to manage this cash now becomes more paramount. How much do they reinvest in the company, how much remains on the balance sheet and how much is returned to shareholders? Then, a late stage company (i.e., not growing much, but still creating cash), is most concerned with returning cash to its shareholders.
A savvy executive team will make the right decision throughout the company’s life as long as they never forget that their job is to act in its owner’s best interest (i.e., the shareholders). If they do this, a company can continue to be a great investment regardless of its growth prospects. Ten years from now will you really care if Apple is not selling more IPhones if the cash generated from services offered on existing IPhones is so great that Apple is returning tons of money to you as a shareholder via stock buybacks and dividends? So much so it is exceeding your required rate of return!
Let me answer that for you… NO! As a shareholder you are interested in your return on investment and the reason you invest in public companies is because they are also in the business of creating positive returns on investment (capital). Needless to say, managing capital is key to hitting this shared goal.