Stock prices change minute to minute based on investor perceptions and emotion. Investors compare the current price with current – and expected – earnings.
Over the longer term, it is earnings which will determine the trend of a stock’s price history. You would (correctly) expect that if Company A’s earnings rose by 25% a year for 10 years, while earnings for Company B fell by 25% a year, that the price of Company A stock would have gone up dramatically, while the stock of Company B would have fallen drastically.
One metric that investors use to compare the stock of different businesses is the PE Ratio – a simple division of the Price by the Earnings per Share (usually for the last 12 months). As optimistic investors put more money into a particular stock, the price goes up, and with it the PE Ratio also goes up.
Optimism implies that investors expect the future prospects for a business to be good. If business really is going to be good, you would expect the managers to try to put more capital to work. The business can get this capital in several ways.
It can borrow the capital, either from a financial institution or by floating a Bond Issue. It also can raise funds by issuing more stock. There are good reasons why a company might do both.
But, what if a company has a history of buying back its own stock? If the total earnings keep going up, this indicates that the officers couldn’t find a better use for the money.
If total earnings are flat, or are declining, Buy Backs mean that the people running the company are stealing from the shareholders! Why would any responsible person buy an investment which he expected to go down?! The main reason is that the managers may have a stock option, bonus, or other incentive program which rewards them if the stock price goes up.
When the managers bought back their company stock, they reduced the number of shares outstanding (duh!). The total earnings then got divided by this smaller number of shares to get the Earnings per Share. They have financially engineered – fabricated – a rise in EPS, so that the trend will look good to investors, who then do more buying.
Together, the Buy Backs and the induced investor purchases cause the price of the stock to go up, and the managers benefit. When I was a kid, they used to call that stealing – I’m not sure why the don’t call it stealing today.
In recent years, as the Economy has suffered greatly from the headwind of stupid policies coming out of Washington, DC (and the various state capitals), more and more corporate managers have been resorting to stock Buy Backs.
Last year, over $1 Trillion was used to Buy Back company stock. All these purchases are negative votes on the underlying businesses. All these managers thought there was no better use the company could find for the money.
As I said earlier, if business prospects are good, managers ought to be looking for more capital to put to work. But, with Buy Backs, we have capital being removed on a massive scale.
Taken as a whole, all these companies are eating away capital. They are eating the seed corn for future years. The are not simply saving their capital until the day when voters throw out the socialists and elect candidates who have at least some clue on Economics. They are making their companies smaller.
These companies’ managers have all but given up hope for our Economy. In many ways, this is a self-fulfilling prophecy. By reducing the available capital within our Economy, that capital is not available for future growth. That capital no longer is available for simply replacing equipment as it wears out or becomes obsolete.
On a company by company basis, it is the shareholders who must step up and throw out the thieves. But for the Economy as a whole, it is up to the voters to use their power to end the stupid policies. The longer it takes, the poorer our country will become, not only relative to what growth we could have had, but poorer absolutely.
We have 50 Million Americans on Food Stamps today – how many more Americans in poverty can we stand? The social divisiveness in our country has grown mightily as stupid government policies have run rampant. At what point might social divisions become so great that our country can not exist an longer?