A company buying back its own shares should suggest questions. Is it because the business has surplus cash and can find no way of growing the business? Is it a failure of management in finding nothing in the business in which to invest? Is it just an attempt to make its figures look better by boosting the earnings per share, and increasing its share price? Or is it a sign that the business thinks this more sensible than buying overpriced assets through a business takeover?
The shares bought back can be cancelled by the company or kept in ‘treasury’ for release at a later date.
Companies are obliged to tell the Stock Exchange authorities about dealings in their shares by directors. This goes out on the Stock Exchange’s news system and is occasionally picked up by an increasing number of newspapers.
Directors may provide very plausible reasons for selling, but it is best all the same to be wary and check what is going on. The director may really need the money for the children’s education, to pay death duties, to buy a small chateau in the Dordogne, or to fund a contentious and expensive divorce. But even then, why did that director sell those shares to find the money? Without convincing explanations, one really does wonder what the managers of a business know that other shareholders do not when they start selling the shares in substantial quantities.
Conversely, the fact that several board members seem anxious to increase their holdings does seem pretty encouraging even if they are not acting on insider information. Directors are allowed to trade in shares only when they are not in a ‘closed period’ of sitting on sensitive information, such as the company’s latest set of results or news of a contract won.
Fads overtake the world of investment with even greater virulence than women’s clothing, and are equally evanescent. The internet bubble is an example, but at least that was related to some underlying business opportunity. It really was true that the system was changing the way people do business, but nobody knew how much or how quickly, much less who was going to win during the trading revolution. As a result there was no obvious way of valuing an internet company. Valuation was made additionally difficult by the variety of software producers, internet service providers, retailers, etc. P/E ratios became insane or irrelevant (there were no earnings yet) and everyone knew the businesses were overvalued, but there seemed no way of stopping the boom – until it stopped.
Unlike the internet fashion, which at least derived from some confused perception of what really was going on, some fashions seem based on nothing but vaporous unrealistic hope. The point here is twofold: it is not wrong to invest in a promising sector such as the internet so long as you can see real value in the business, but it is folly to get caught in the hysteria; and it is vital to separate the booms that are based on real business opportunities from the ones that are nothing but passing fads apparently created by some sort of market ramp.
Sometimes a big takeover in a sector – banking, insurance, pharmaceuticals, retailing and so on – prompts speculation that others will follow, and most of the shares in similar businesses suddenly romp ahead. Whether there is a sheep-like mentality in business, whether financial advisers then see the chance of income and urge their clients to grab a share of what is left, or whether managements really do fear being left behind, the speculation quite often becomes fact. It happened with the demutualization of building societies and insurance companies. When one of those became a public company, owners of the others could not resist the lure of short-term profits and forced a flurry of demutualizations.
When there is a general realignment in the industry of this type, the people who spot it at the start and buy into the companies likely to become takeover targets see healthy rises in the shares. Similarly, carpetbaggers getting into the building societies in time emerge with a few thousand pounds of shares that they can swiftly extract.
Another fashion is for sectors. Suddenly biotechnology is seen as the saviour of mankind with untold riches to be derived from new drugs; software companies are seen as the universal traders; the internet is thought to be a guaranteed means of selling to hundreds of millions of people at no cost at all; or a mining sector is reckoned to be certain to make a fortune from the spurt of demand for its metals. Vogues of this type seldom last more than a year, so it takes nimble minds to spot the trends, but the results can be spectacular. It is possible to increase the value of the holding by anything from five-fold to 20-fold in a matter of months. The point is to get out before the sky falls in.
Conversely, it is dangerous to climb aboard a bandwagon if it seems to have no real engine. If you do not understand what a company does or why it is valued as highly as it seems to be, avoid it.
If you have a stockbroker who is providing more than just a dealing service, or an investment adviser, there will be ample advice and information on tap. It may be very good advice, but intelligent investors are not wholly inert, prepared to accept everything they are told. You get better advice if you are informed enough to be able to discuss the market and your needs in an intelligent manner. The investor needs to be continuously keeping up to date and to have his or her priorities clear. This is not just a useful antidote to being baffled by pretentious jargon: it also helps establish whether one’s ideas are right.
People without a regular financial adviser and those who distrust the advice they get have to hunt around for other sources. Stockbrokers’ circulars are still generally available to them either directly or through the press, but usually after favoured clients have been told the conclusions and have had time to act on them. This is useful information because it gives a lot of background about a business, the calculations and feelings of a professional, and an indication of how the City may view the shares. You can then check what you feel, what the share price is doing and so on, and use the additional insight as an extra aid in decision making.
If you do not have access to a broker’s advice, do not despair. Stockbrokers are as likely as anybody to be wrong. A classic case was the carmaker British Leyland. For about two years prior to its demise, investors were getting more and more nervous about the unruly unions, the shoddy workmanship, the short-sighted management and the increasing signs that the company could not make the cars the market wanted and was ill-prepared to make the profound changes needed. So its share slid steadily. Nevertheless, stockbrokers queued up throughout that inexorable tumble into insolvency to recommend the shares as a good buy.