Class Warfare Blog

December 21, 2016

Stock Market Games (for Fun and Profit!)

You all remember the story we were told about the stock market when we were in school: companies sell stocks to provide them with the capital they need to expand or whatever. Those stock certificates paid dividends, a bit like interest, and could be sold or given to other people. That’s the story we were told and from that it sounds like a good deal, a way to bolster businesses.

Let The Games™ begin!

From that humble beginning all sorts of “conventions” were created. One such is that companies had to report, honestly, their earnings for each year and they had to undergo “independent” audits by reputable accounting firms, like Arthur Anderson.

One of the key markers of a healthy stock is their companies earnings per share of stock for the year. Most people thought this would be a good metric because the more the company earned, the more they could invest in further growth and/or pay more in the way of dividends.

But then a number of folks in these companies realized that the fraction labeled “earnings per share” had a denominator. To get a larger “earnings per share” number you had to either bolster your earnings (increase the numerator) or … or diminish the number of shares (decrease the denominator). Enter the age of the “buy back.”

According to Wolf Richter (What the Heck’s Happening to Our Share Buyback Boom?):
Companies in the S&P 500 spent about $3 trillion since 2011 to buy back their own shares, often with borrowed money. It’s part of a noble magic called financial engineering, the simplest way to goose the all-important metric of earnings per share (by lowering the number of shares outstanding). And it creates buying pressure in the stock market that drives up share prices.

So when a company buys its own shares back, the number of shares available decreases which makes the “earnings per share” automatically higher. Also, the purchasing itself shows higher demand which leads others to pay more for that stock, making the CEO’s stock options worth ever so much more. What could be wrong with this?

Well, for one thing, these companies are not buying back their own stock with surplus cash (aka earnings) from previous years, they are borrowing money to do this. Mr. Richter continues:
And much of it is funded with debt. Over the past three years, aggregate debt of the S&P 500 companies has grown 1.7 times faster than aggregate cash and short-term investments, according to FactSet.

So, the company takes on more debt but the CEOs and other stockholders benefit in the short term. Isn’t this what Republicans say the federal government shouldn’t do: borrow money for current benefit, to be paid back later by other people? Apparently it matters who is the beneficiary of this kind of activity. If ordinary people benefit, like when the feds issue bonds to fix infrastructure, their against it, but when business want to do it, they become enablers. Again, Mr. Richter:
This is a nasty wrinkle in the buyback scenario. But there’s hope. Trump has pledged to change the corporate tax code, and/or give corporations a tax holiday on this “overseas” cash so that they can “repatriate” it, by selling their US Treasuries and other investments and using the proceeds to buy back their own shares. That’s what happened last time the government granted this kind of tax holiday in 2004. And everyone is hoping that it will happen again. I suspect that’s one of the reasons for the surge in stock prices since the election.

As long as the Fat Cats are for it, so are the Repubs, even including the guy who ran against the Fat Cats during the election.

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