From our 0.2 of a professor

It now looks as if it could be said that the panic is over. I beg to differ. Indices do not tell the whole story.

First that is because they can be manipulated. Share buy backs are, for example, a deliberate exercise in share price inflation.

Sigh:

In the FTSE indices, share prices are weighted by market capitalisation,

Share buybacks raise the share price, ceteris paribus. That’s the point of them. But they raise the price by reducing the number of shares in issue. That’s the point of them. Thus the effect, ceteris paribus, of the share buyback upon market capitalisation, and thus the index, will be zero.

16 thoughts on “From our 0.2 of a professor”

  1. Thus the direct effect of the share buyback on market capitalisation …

    Ritchie can’t do even first order effects. We should at least recognise them, even if we can’t actually calculate or even estimate them.

  2. It is sad but not unexpected that he believes that share buybacks are made solely to manipulate share prices. I would suspect that for a lot of companies , they represent a better way of using any spare cash than just throwing it willy-nilly into “investments”

  3. Could be I have missed something but I doubt it is quite as neat as the reduction in # of shares cancelling out the price rise from a share buyback – that’s the theory, but given the number of confounding factors I doubt its a net zero effect in most cases.

    For example, imagine a company whose prospects make it look an unattractive investment go for a share buy back to try and get some price movement in the market and make the directors look a little better to the investors. If there are few people willing to buy, and lots willing to sell it could be that the price hardly moves, as despite the buyback there is still an excess of people looking to offload. It could even cause a overall share price loss, as the market takes the view that a share buyback in this case is the last refuge of an executive team out of ideas so they unwittingly make the company look even worse than before.

    My old corporate finance lecturer, having spent many years in the City before moving to academia, used to have a good chuckle when talking about rational analysis of share prices and market moves. “It’s run by two things – fear, and greed” she used to say.

  4. Andy H

    All the evidence suggests that you are right to be suspicious. It used to be that it was suspected that directors, targeted for bonuses on EPS rises, used share buybacks to manipulate EPS. Nothing about trying to engineer share price rises. Empirical evidence is hard toi come by.

  5. Andy H

    “given the number of confounding factors”

    Hence Tim’s use of ceteris paribus.

    But the point (I think) is that Murphy thinks share buy-backs are behind the FTSE stabilisation because they push the SP upwards when, as Tim points out, the FTSE is a capitalisation index which takes account not only of share price but also the number of shares in issue.

  6. AndrewC

    It is as if Murph is being even more stupid than usual in that:

    First, he is unaware that FTSE is a capitalisation index,
    Secondly, he is unaware that share buybacks do not automatically lead to share price rises,

    and so on through to tenthly, with a lot of spittle and fist-pounding

  7. Ritchie must have ‘the market crash is imminent’ noted for publication every 3 months or so, followed by a month later why it didn’t happen but why he was right anyway.

  8. I’m shocked, SHOCKED that m/k > m/l, where l>k! You can’t expect people to possess such esoteric knowledge.

  9. The funny part here is that Ritchie routinely calls for extension/creation of precisely the kind of policies that lead to share buybacks – because the buybacks are part of a greater trend of people unable to take on the degree of mortgage risk they’d like (and can support) finding other ways to add leverage to their portfolios.

  10. Surely there isn’t anywhere near enough volume of share buybacks to move the entire market let alone influence it long term.

  11. “Ritchie must have ‘the market crash is imminent’ noted for publication every 3 months or so, followed by a month later why it didn’t happen but why he was right anyway.”

    He is no different from the Daily Express and their annual “Killer winter storm” headline in the second week of October. He will froth with rage at the comparison but he really has no clue whatsoever.

  12. SJW
    No. The argument is that the cash on hand provides a low return. The PV of future cash flows (and hence the aggregate value of the firm) will come from high-return opportunities (including current operations), of which enterprise has too few. Making all the high-return investments and then buying back shares with the remaining cash leaves the future cash flows intact.
    The argument depends on the belief that management can correctly assess likely returns, and perhaps the counter argument that management, if left with excess cash will find a way to invest it badly.

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