A Journal opinion article - Essay Example

Levin acknowledged in the article that the practice of buybacks or companies buying its own stocks is unhealthy and proposed that the general public should be notified beforehand for greater transparency. But as it is, buybacks are still practiced and if one thinks that this helps America’s economic recovery, it does not. The pracitce of corporate America of buying back its stocks will not help to recover but in fact will threaten its economy. It seems that we have not learned our lesson after all as we are again back at manipulating balance sheets to have a perception of value.

Corporate America is again practicing the same principle of financial manipulation that precipitated the mortgage criss that brought us the “Financial Crisis” that took America to recover and this recovery is even questionable today. Buying stocks back is just a convenient way of unloading those excessive cash in the guise of avoiding dilution and increasing stock value. To finally recover from the crisis that we are in, values in terms of productivity has to be created. Coupled with healthy spending that will translate to a robust domestic consumption which will have a ripple effect of encouraging more production.

In other words, for us to recover, plants has to be erected, new technology has to be developed, companies has to hire employees or engage in any economic activity that will create “real value” and not just buyback stocks to increase it value. Buying back stocks does not do this although it will convey the perception that a company is performing well. To explain this further, it will serve us well to cite an example to better understand how stock buybacks create a perceive performance without creating any real value.

Let us assume a company buys back a million shares at $ 5 per share with a $10,000,000 cash. Profit is at $1,000,000. Observe how return on assets, return on shares and price earning ratio improve without any increase in profit. Before Buyback After Buying Back Cash $ 10,000,000 $ 5,000,000 Assets 30,000,000 20,000,000 Profit 1,000,000 1,000,000 Outstanding shares 10,000,000 9,000,000 Return on Assets 3.33 % 5.00 % Return per share $ 10 $ 11.11 The above illustrates how a company increases its perceived value without an increased productivity.

It just unload the cash of $10,000,000 by buying back a million shares at $10 per share. The cash diminished to $20,000,000 ($30,000,000 cash minus $10,000,000 buyback) increasing the return on assets to 5 % (1,000,000/20,000,000). Above all, the price-earnings ratio (P/E), the ratio which is often used as a measure of value of the company also increased without creating any “real value” (lower ratio is better). Where before the P/E ratio is 50 ($5/$10), it decreases to 45 ($5/$11.11) by simply unloading its cash by buying back its stocks.

This is what Levin is discussing in the article “Secret Buybacks Are Unfair to Shareholders“. Companies are creating perceived value with the increase in return on assets, improved price earning ratio and higher return on share without creating anything. Companies only intend to give higher dividends to its stockholders which