Thursday, January 24, 2013

The misconception on share repurchase

The amount of negativity I have read in some the Malaysian forums and blogs on share buybacks are to me unjustified. There are claims whenever a particular stock had a sharp drop, and when the management decided to or rather acted on the price by buying back shares, it was viewed negatively. I feel that we just have to look at the companies themselves to see whether the action is justified. To be frank, I have tried to find missteps in the behavior of some companies when comes to doing buybacks, and it was quite tough for me to find companies that have done injustice to shareholders doing so.

Many of the companies that have done buybacks are on paper undervalued, at least to their book value. Most of them have very manageable borrowings and in fact many are in net cash positions.

I have put commentaries on buyback herehere and here. From the three articles, the only company which I have highlighted possible over-used of the buyback weapon is Pelikan. On that note, the company was doing buyback while the major shareholders were selling.

Buyback can be wrongly used to shore up the price of the companies shares especially when they are not undervalued. During one meeting that I attended, a very popular local fund manager who was starkly against buyback has used the example of JP Morgan's Jamie Dimon admitting mistake that he has bought back too much of his company's shares. After looking through, the halt on share repurchase by JP Morgan was not due to a wrong buyback decision. It was due to the one off event where JP Morgan had a huge trading losses caused by its London office last year, and the decision not to buyback shares was due to it wanting to shore back the capital ratio of the bank due to Basel 3 requirements.

In fact, the same fund manager was against buying back its own company's closed end fund when the shares were (and now still are) trading at substantial discount to Net Book Value. I in fact was very disappointed when he vehemently rejected the buyback suggestion indicating that share repurchase is the wrong weapon to use. Again, I am questioning if the share price is undervalued, what's wrong to do repurchase on your own shares especially when you have the funds to do so? That closed end fund actually has 1/3 of its assets in cash and for now he could not find better use for them with the cash sitting in the money market earning somewhere around 3%.

Announcement on decision to buying back shares as made by Jamie Dimon who indicated that he is willing to do more buybacks this 2013 year would have caused many to relook at the company again. As it is, JP Morgan is now trading at below book value and based on its Trailing Twelve Month's earnings its PE is below 10x. Wouldn't the share price be undervalued for a bank which is growing fast due to the recovery of the American economy. And based on that why would he not be buying back his own company's shares?

Recently, Warren Buffett has gotten approval from his board to buyback shares of Berkshire Hathaway in the instance where the company's shares are traded at below 1.2x book value. That instantly caused investors to look at the company again. As an investor, if I feel that the company's management has made the wrong decision, I can of course opt not to hold to the shares, and if it is done correctly due the price being undervalued, wouldn't it be beneficial to the shareholders?

Yes, any action - there can be positive or harmful to the company, but if it is communicated and explained well, perhaps shareholders can have a better view on where the management are heading.

1 comment:

Vic Lavendy said...

Shares buyback done at arms-length and at prices above co's NTA are alright provided Co. does not have upcoming capex/acquisition requirements. However,when buybacks are used to purchase insiders holdings and when these Cos. soon after buying back announce rights (or other fund raisings) are suspect.