RE: Jesse Felder’s full quote on stock options:
“GAAP accounting, which S&P 500 companies use, allows for a stock option to be granted and then expensed over time using the value of the option at time of the grant. NIPA accounting only expenses the option once it has been exercised, usually at a much later date and with a much higher expense.
The ‘large discrepancies’ between corporate profits and S&P 500 profits then can probably be explained, in part, as a product of the difference in using tax accounting and using GAAP accounting for stock options. Tax accounting has resulted in a much larger expense than GAAP accounting in recent years simply because the value of the options have grown a great deal along with stock prices over time.
In short, it seems that the boost in earnings over the past few years in S&P 500 profits could be, to a large degree, merely a product of the bull market rather than the other way around. Investors have crowded into a smaller number of firms that have inordinately benefitted during the current cycle and, in part, due to this crowding, these same firms have been able to report even greater profits by way of a quirk in stock option accounting.
The question investors should now be asking is this: ‘Is this recent earnings trend sustainable or is it merely the product of an equity bubble?’ As the 2000 experience shows, it’s more likely to be the latter.”
RE: Graphic examples of imprudent share buybacks that led to emergency sales at depressed prices to prevent a solvency crisis (and a questionable move involving Boeing’s retirement plan):
For all of you who are based in the Pacific Northwest, our local aerospace juggernaut, Boeing, is another case study in mismanaging buybacks. Fortune Magazine, certainly no foe of big business, pointed out in an article in early 2020 that, since 2013, Boeing splurged to the tune of $43 billion on repurchases (paying as high as $385 for a stock that would sink to $95 in the spring of 2020). This was in contrast to just $15.7 billion it spent on research and development (R&D) for its commercial aircraft division.
The Fortune article asserted part of the blame for the 737 Max fiasco – which had already cost the firm $9 billion, a tab that is almost certain to rise much higher – was due to the diversion of resources to buybacks. (Since those words appeared in our 2/14/2020 EVA, the tab has doubled and continues to climb.) Boeing compounded its previous errors by borrowing money to pay dividends at the same time it was reducing R&D spending.
More egregiously yet, to alleviate its extreme cash crunch caused by the Covid convulsions, it did the following in the company’s own words: “In the fourth quarter of 2020, we contributed $3 billion of our common stock to our pension fund. In the fourth quarter of 2020, we also began using our common stock in lieu of cash to fund Company contributions to our 401(k) plans for the foreseeable future, which we estimate will conserve approximately $1 billion of cash over the next 12 months. Under this approach, common stock is contributed to our 401(k) plans each pay period. We expect this measure to further enable the Company to conserve cash. We have retained an independent fiduciary to manage and liquidate stock contributed to these plans at its discretion.”
In my opinion, such activities should be illegal. Boeing is almost certain to be a survivor but imagine the hit to plan participants had it failed, as many once blue-chip companies have in past decades (Kodak, Polaroid, Sears, K-Mart, Enron, WorldCom, Lucent, to name a few).
Airlines, of course, were in even worse shape than Boeing, which had a highly profitable defense division to help it stay aloft, as travel came to a virtual standstill and their revenue crashed to a previously unseen degree. The entire industry was spewing red ink at a rate that made the Great Recession look like boomtimes. American Airlines, for example, lost roughly $10 billion or around $20 per share. To stay in business, it sold 200 million shares for $ billion at the yard-sale price of $ . This almost precisely reversed the shares it had bought back since 2015 at prices as high as $50 per share. In other words, it caused massive value destruction for shareholders.
RE: Sen. Marco Rubio’s harsh words about buybacks:
“The justification for corporate buybacks is a company has no better investment available. This may be true for any company from time to time. But what does it say when it is true for many companies year after year? Since 1980 (there has been) a trend of corporate profits flowing back into financial markets and less of these profits invested in increasing productivity through innovation, technology, equipment, etc.
The result is not enough increase in productivity, growth, or widespread prosperity. The argument buybacks are good because (they free up) money to reinvest in other businesses growth isn’t backed up by the facts. Over the last 40 years money back to shareholders has tripled as a percentage of GDP but investment into businesses has dropped by 20%.
Right now, (we) don’t have a ‘free market’. We have a tax code which engineers the economy in favor of inflating prices of shares at the expense of future productivity and job creation.”