Back in the 1980s, stocks would go up when they declared a rights issue. The logic then was if you could buy more shares at a discount, it was a good deal. In the 1990s, this thought was found to be flawed and rights issues no longer caused stocks to go up. Instead, rights issues now cause stocks to go down as it signals that the company is not doing well and needs capital infusion from its shareholders.
Back in the 1990s, stocks would go up when they declared a bonus issue. The logic then was if you could get more shares for free, it was a great deal. Moreover, companies would only declare a bonus issue if they had been profitable for several years. In the 2000s, this thought was found to be flawed and bonus issues no longer caused stocks to go up by as much. The current wisdom is shareholders would still own the same proportion of the company even though they have more shares on hand. Stocks still go up by some extent, because there will be more dividends (due to more shares) and it signals that the company will continue to be profitable in the foreseeable future.
Back in the 2000s and now, stocks would go up when they declare a share buy-back. The logic is it signals that the company is profitable and generating cash in the foreseeable future and has no need to keep so much cash. And the higher the price at which the share buy-back is conducted, the more confident the market is of the company's future performance. Fast forward to 2020s, and this thought of higher buy-back price equating to better future performance will be found to be flawed as well. (The basic logic that the company is profitable and generating cash in the foreseeable future remains correct). Why?
It is because when companies decide to return cash to shareholders via share buy-back, the total amount of cash is fixed, but not the price at which the share buy-back is conducted. Consider a company with 100 million shares, has $10 million to return to shareholders and its current share price is $10. It could return the cash to shareholders as a dividend of $0.10 per share, buy back 1 million shares at the current market price of $10, or buy back 0.5 million shares at double the market price of $20. All 3 approaches would achieve the same objective of returning $10 million to shareholders and the company would be indifferent to whichever approach taken. But the third approach would thrill the market as it signals that the company is likely to do very well in the foreseeable future (as compared to the second approach). This is far from truth, as the company's intention is only to return a fixed amount of cash to shareholders. If the company's prospects were indeed so good, why wouldn't the company's management take over the entire company? Unless the share buy-back is applicable to all shares, it would be prudent to ignore the price at which it is conducted.
It is fascinating to watch how the market reacts to corporate actions over the years. I wonder what would be the next corporate action that thrills the market in 2020s.
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