Tuesday, August 18, 2015

8/18/15 Investors as forced margin buyers of stock

As a former financial manager, I find stock buybacks curious from a cost of capital point of view.  Corporations have been buying their stock back at high prices with low cost debt.  Well, with such low interest rates I guess the cost of debt is less expensive than the cost of equity if the company is paying dividends.

According to astute John Hussman of Hussman funds, borrowing to finance buybacks is putting investors in the position of margined buyers of stocks.

When the stock market goes down, margined owners of stock start selling creating supply that accelerates the downside move in prices.  What does that mean to companies that have purchased a lot of their own shares with debt?  Do they start issuing shares to pay down the debt they acquired for buying back shares?  Surely they would be selling new shares at a lower price than what they paid for them in the buybacks.  This would leave permanent debt on the balance sheet.  Wouldn’t it?  With permanent interest to pay.

Ok.  So for a period of time the corporation paid less in dividends due to a lower float.  But issuing new shares just means they are back to paying more dividends.

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