The nonsense is on the rise in the markets – and since companies are now buying back their own stocks to inflate their own balance sheets, why not just take the next step?
There was a time when we found it odd that companies would buy back their own shares.
They are supposed to make investors’ money grow by providing goods and services … not by betting it on the stock markets.
Businesses create wealth by earning profits – generated by making and marketing things. They take raw materials at cost X… add labor at cost Y… and sell the finished product at price Z.
As long as X + Y (we are simplifying) is less than Z, the world is enriched by it. We “added value”.
However, for at least 30 years, the Federal Reserve has actively inflated the financial economy (asset prices) while slowing the real economy (sales, wages and profits).
The relative size and profitability of the product and service offering – compared to the rapid excitement and leverage of Wall Street – has declined.
That’s why mothers these days want their babies to go work at Goldman Sachs in New York, rather than become an engineer at Industries & Co.
Even the CEOs of old-fashioned industrial companies are tempted by financial sleight of hand. The buybacks, ie share buybacks, for example.
Businesses often buy themselves “sales” by acquiring other businesses. Usually, they buy the company at a rather low cash price… and then take advantage of a higher valuation in the markets.
Thus, the more the prices rise, the more attractive it seems to buy the sales and profits of another.
The S&P 500 currently has a PER of 42… the third highest in history. Large corporations borrow at a rate of around 3% (the yield on the most creditworthy AAA debt). Inflation is around 2%… and is increasing.
So if you can buy a business at 10 times its income, said income will be worth four times as much in your enlarged company.
And if you can borrow at a real interest cost of 1% – factoring in inflation – the deal should be extremely profitable for you. As a CEO, you should be getting a nice bonus.
Buying back your own stock is not exactly the same as buying another business … but again, it can give more sales (and profits) per share to your shareholders, a rise in the price … and a bonus for the CEO.
A plausible absurdity
Why stop there?
For example – and this is just a hypothesis out of our imagination – if a company can increase its value by borrowing money to buy its own stock, maybe it could inflate sales and profits by borrowing to buy. its own products?
In the digital economy, additional sales can generate almost 100% margin. Obviously, even in the “old economy”, if a company did not need to supply a product, its margin would be close to 100% there too.
So imagine a business that borrows a billion dollars at 3%… and uses the money to buy its own products.
It has no manufacturing or labor cost, no shipping cost. No customer service or refund obligations. It will be the best deal the company has ever made.
Yes, that’s absurd… but a lot of things are actually happening right now.
And yes, with such an arrangement, the company will have to pay $ 30 million in interest. But that increase in sales and profits would be multiplied to give $ 42 billion (one billion more profits, multiplied by a PER of 42) of additional value for the stocks.
Shareholders would be delighted. Traders and Reddit fans would take the bite out and probably double the title.
We can consider a boost of $ 50 billion in capital… at the cost of only $ 30 million in annual debt service costs. Not a single penny of real wealth, linked to concrete goods and services, will have been created. But everyone would get rich.
In other words, the maneuver would be enormously profitable.
Obviously, the idea is silly. But at least it is plausibly absurd … that is, it stays within reason, as a madman might imagine.
We are waiting for someone to launch.
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