Month: March 2020

Thought for the day

Is it foolish to think that anyone, especially Congress using a political process, can wisely determine where and how much economic aid should be provided to businesses or individuals?

The intended and unintended consequences may be worse than if Congress does nothing.

Stock Buybacks

Reading just headlines some have pointed out that there is an HBR article that says stock buybacks are dangerous for the economy/

https://hbr.org/2020/01/why-stock-buybacks-are-dangerous-for-the-economy

But it is the swapping of equity for debt that is the warning from the HBR article. We have this moral hazard for corporation management because the Federal Reserve is manipulating interest rates. The cost of equity capital for a company is approximately the reciprocal of the P/E ratio. So for a stock with a P/E of 15, the cost of equity capital is 1/15 = 6.6%. With debt capital only costing 3% or less, management is enticed to take on the risk. The problem is that taking on debt requires them to make regular interest payments, while equity capital can suspend dividends whenever they want. Taking on debt to buy back stock is bad. Distributing cash also reduces the a company’s chances to weather a downturn so management needs to consider that before a buyback. But investing the money into growth activities for the company that don’t work out also reduce the safety of the company.