Thread by @MebFaber

Politicians, let's say you really care about solving the stock buyback issue.

Here's how you do it.

First, understand being a public company founder or CEO is hard.

It's really, really, really hard.

(Background Reading)

mebfaber.com/2019/08/05/faq…

In fact, many companies fail.

About two-thirds of stocks underperform a broad index.

About half have a zero rate of return over their lifetimes.

About a quarter essentially goto zero.

We often are biased to the ones that have survived, but this is a tiny minority.

Every day CEOs are faced with tough decisions, and they only have five levers on how to spend their cash.

1. Reinvest in the business.
2. Buy another company.
3. Pay down debt
4. Pay a cash dividend.
5. Buy back stock.

That's it. There's nothing else.

A CEOs goal is to maximize how best to spend that money.

99% of people only focus on #1, as it is the sexy option.

R&D on new products, launching new lines of business, new hires, advertising and putting their names on buildings, etc.

But the rest are equally important.

Most politicians have never run a biz, It's easy to say, "you need to invest and hire more people!".

But what if you don't have any good ideas?

If your company makes brooms, is ramping R&D a great idea? Will hiring 1000 people help to invent flying brooms?

Probably not.

Or, what if you have what you think are good ideas but the outcome is uncertain?

You launch what you think is a world changing product, and.....no one cares.

There is no product market fit.

Well, in hindsight, a waste of money.

You could also use the cash for #2, buying another company, and the media loves this one!

Guess what? That probably results in synergies and lots and lots of headcount reductions...

(Odd that private equity is immune from this discussion as they routinely axe tons of jobs)

But maybe you're just the world's top broom maker, and your competitors are weak. Well, what then do you do with your cash?

If you have any debt you could pay it down.

If you don't, what then?

You return it to shareholders.

There's only two ways to do that.

Cash dividends, which force your shareholders to take them even if they don't want to and they get taxed on it.

Investors can then recycle that dividend into growing and more innovative companies.

Or, if you think your stock is cheap, you can buy it back.

(Did you know that for most of the last few hundred years investors and governments wanted companies to buyback shares so CEOs couldn't squander it?)

wsj.com/articles/the-f…

A good CEO would have a metric, like @WarrenBuffett P/B for Berkshire, where buying back stock is reasonable.

At fair valuation, this is the exact same thing as a dividend but more tax-efficient.

At a discount to fair valuation, as Buffett states

"When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases."

@wolfejosh / @mjmauboussin had a nice flow chart that demonstrates the CEO's decision flow here...

Ok, so, why do so many gurus and politicians hate buybacks?

Let me give you an example. @JoeBiden just tweeted, "I am calling on every CEO in America to publicly commit now to not buying back their company's stock over the course of the next year."

Why single out buybacks? Here's an example...

Let's say last year our company Wonder Brooms has $600m cash from their core business of selling brooms to sweep out your garage.

But that biz is stale so they decide to pivot.

So, this year they:

1. Spent $100m on flying broom project & spent $100m on ads for flying brooms.
2. Bought Scuba Brooms for $100m.
3. Paid down $100m in debt.
4. Paid $100m cash dividend.
5. $100m buyback.

A year later, it turns out no one wanted flying brooms as they tended to crash. And the market for scuba diving on brooms was smaller than they thought.

Now they're out of cash and want a government bailout as they have no money left.

And all the media cares about in this scenario is buybacks. Were buybacks stupid (in retrospect), yes!

Was it stupid to pay a dividend, yes!
Was it stupid to pay down debt (maybe), yes!
Was it stupid to buy Scuba Brooms, yes!
Was it stupid to pivot to flying brooms, yes!

But again, this is Monday morning quarterbacking. What if we all went full Harry Potter and loved flying brooms?

Well, you're the next @BillGates. And you bought back stock when cheap. It turns out people like to scuba with brooms too, brilliant! Dividends just went up!

They whole key here is that running a business is freaking hard. And do you have some moronic CEOs? Sure. But my guess is they are a small minority.

Should most companies failing today due to a pandemic have built a more anti-fragile business? Probably. Perhaps. Maybe not.

Was it fragile because they bought back stock?

Or because they paid out way too much in dividends?

Or just dumb biz decisions like buying stadium rights and renaming it Wonder Broom at Mile High?

Or was it just tons of competition all over the world?

It's not so clear, is it?

Hopefully you can see that buybacks are just a tool, and honestly a pretty boring financial one at that.

So why do politicians get all hot and bothered about buybacks?

First, because it "sounds smart".

And they need a bogeyman.

We all know exec compensation is high, and labor's share has not kept up.

Many politicians equate high exec compensation with buybacks. But it has nothing to do with buybacks!!

Here's an example...

Let's say Wonder Brooms brought in a new CEO last year and the board decided to pay him $100m. Well, that's probably stupid. But it has nothing to do with buybacks.

Or, let's say the board only pays $10m, but ties bonus to short term stock price targets and EPS.

Well, that is also stupid. It's only related to buybacks in that the board is moronic and designed an idiotic incentive structure...

Almost all of these are board issues with stupid compensation incentives.

And to be clear, if a business fails the equity should be wiped out. Full stop.

Fine to let company go through bankruptcy and preserve jobs and assets, but execs and stock are zeros.

Ok, enough ranting and some solutions.

1. Make boards accountable, and eliminate compensation tied to short term results and earnings per share. Again, a board issue.

2. If you really want to nullify buybacks, then take away the double taxation of dividends.

(Politicians will never do this as they are addicted to tax revenue. Just like they will never eliminate the lottery either despite being predatory and bad for constituents).

3. Another suggestion? Teach personal finance in high school. Over 80%+ of high schools don't teach it and yet we expect 17 year old kids to make a decision about taking on tons college debt?

C'mon.

Why should we expect politicians to understand stock buybacks?

Lastly, we need to lift up our businesspeople, founders, and entrepreneurs and not demonize them.

It's really, really hard. Listen to this recent podcast with @patrick_oshag & @BrentBeshore ...

investorfieldguide.com/beshoreupdate/

We should encourage everyone in America to get rich by investing in businesses, we need more investors not less!

mebfaber.com/2020/03/05/the…

Would love to see the government create a universal retirement account with much higher limits ($50k) to expand the middle class.

If you want some more reads on the topic, check out my favorites here...stay safe everyone!

mebfaber.com/2019/08/05/faq…