Stock Buyback Scams

Some finance junkies are thinking, and what about stock buybacks? Public companies have returned hundreds of billions of dollars to investors through buybacks. The critical word that is missing from their vocabulary and calculation is dilution: the additional shares public companies print before and after the buyback. Contrary to what you may have heard from the media, academics, and even Wall Street critics like Bernie Sanders, stock buybacks are not returns to investors. Most buybacks are complete scams.

On the surface, it might look like companies are returning money to investors, but unlike dividends, which are paid and done, stock buybacks can be rescinded when companies print more shares after the buyback. Such dilution can come from initial public offerings by new companies, secondary offerings by existing companies, or employees' stock compensation. All three scenarios add new shares to the market and extract money from investors.

I investigated 1,274 firms that engaged in buybacks between 2009 and 2016 and found 60% of them had increases in their shares outstanding. Between 2004 and 2018, a legitimate stock buyback should decrease a company's total shares outstanding. But 755, or 60%, of the companies showed increases in their shares outstanding around the years they supposedly bought back stocks. This means most buyback companies don't return money to investors; they actually take money from investors when no one is looking.

The existence of false buybacks should not be surprising if you think about it. Public companies like Morgan Stanley and AT&T have been buying back stocks for almost a century. If their buybacks were legitimate, they should have acquired all their shares by now and become private. The reason they are still public is that they print more shares than they buy back.

The following table shows a few of the 755 companies that engaged in false buybacks between 2009 and 2016. The most disturbing thing about the companies on that list is that most of them also pay dividends. In fact, dividend companies made up 539 of the 755 companies that engaged in false buybacks. It was an unexpected and puzzling discovery.

At first, I had problems interpreting the results. It's easy to see why Ponzi asset firms wouldn't care about dilution because they don't have to pay dividends on diluted shares. However, the data showed that the majority of the false buybacks belonged to dividend firms, which shows that dividend firms printed diluted shares without much concern for additional dividend liabilities. If a company is simultaneously diluting while they pay dividends, then the money they are receiving from selling diluted shares to investors is also being used to pay dividends.

The company will not draw a straight line between the two actions, but it's clear that money is going into a pot that gets mixed and paid out to other investors. That's how capital gains work, but it's also true for many dividends as well. Like many of my discoveries over the years, it was not something I wanted to accept when I first saw it, which is why I had a hard time interpreting self-evidence and obvious results.

In addition to the notable diluters, there were also some extreme diluters whose shares outstanding increased by as much as six thousand four hundred and thirty-two percent. These extreme cases were the result of standard dilutions from printing shares and multiple reverse splits in efforts to salvage the stock price. For example, the biotechnology company Sitrex Corp (ticker CYTR) had about eight hundred and four thousand split-adjusted shares at $2 a share in January 2004. By 2012, the price dropped to 32 cents per share, at which point Sitrex did a reverse split and combined 12 shares into one to raise the price to $3.81 per share. By 2017, the price dropped to 36 cents per share, at which point they did another reverse split to bring the price back up to $2.18 per share. By December 2018, Sitrex's total shares outstanding was 3.6 million, which is astronomically higher than what they had in 2004.

The actions of Sitrex look like a form of price manipulation, but it's also legal. But the most important thing to keep in mind is that, from the perspective of CNBC, Bloomberg, and many finance academics, Sitrex is a biotech company with a history of buying back stocks. Finance junkies like to rationalize false buybacks by saying the dilution was probably from stock compensations, not secondary offerings. But if they thought about it a step deeper, they'd realize that stock compensation is essentially the same thing. The only difference is stocks are printed for the employees who will then sell it to investors.

The concept of employee stock compensation is a scam that is closely related to buybacks. Some buybacks are specifically designed to pay the board of directors and CEOs. The top dogs at a company can decide how many shares they want to print for themselves and use the company's money to buy their shares. A stock is worthless unless it can be converted into cash, and sometimes that's how it is converted. But that's not the real scam; that is as legitimate as stock compensation gets.

The real scam is in the perception that companies can compensate their employees with stocks. The simple truth is companies don't pay their employees with stocks; they print stocks. In most cases, investors who buy stocks are paying those employees. Employees don't technically get paid with stocks because they don't want stocks; they want money. The reason they'll take stocks is because they can get their money through the Ponzi process. If stocks are a real form of compensation, the CEOs and employees should hold those stocks forever; they should not feel a need or be allowed to cash the paper they print with investors and pension plans.

The issues with dilutions also elucidate the fact that stocks are not finite. Most companies are not prudent about issuing diluted shares, but freely print as many as they need. The non-finite nature of stocks is also why the idea of voting rights is a complete joke, and stocks cannot be considered or compared to real assets with tangible value. A real asset must have two critical elements: one, it must be finite, with a limited number of owners or shareholders; and two, it must exist with real ownership. They also exist with certain stocks, like Apple Inc., who pays dividends and buys back shares without printing more for now.