As if there was not enough manipulation going on in financial markets, corporations now engage in financial engineering in order to improve the appearance of profitability.
Previously many firms retained a modest supply of cash on hand as a rainy day fund to help survive a recession. That generally has ended as investors want a more profitable use of company funds.
Shareholders want something extra back so corporations started a share buy-back program. That reduced the number of shares outstanding, thus improving financial ratios. With less shares outstanding, profits per share outstanding rose. That barely hurt the company’s total earnings, but the earnings per share obviously increased and improved financial ratios such as return on assets.
Share buy-backs frequently push up the price of shares in the short term to help executives meet targets on which their bonuses are based. Too, they offset any equity issues used to purchase another organization. Therefore, it is no surprise that executives like buy-back programs.
One reason central banks kept interest rates low was to encourage companies to expand/invest, thus helping the overall economy. Yet, with the economy so sluggish, companies have been reluctant to expand. Supply already was abundant, excessive in many industries such as the oil and gas sectors. All this explains the attraction of share buy-backs.
Buy-backs may become less popular as corporate profits appear flat at best. Foreign earnings are in decline in view of the strong U.S. dollar, contributing to shrinking profits and less enthusiasm for share buy-backs to boost earnings per share.
Share buy-backs are just another example of corporate financial engineering. Also, most realistic investors must consider it as bad news if a company can find no better outlet for cash.
Short-term share performance is helped. Furthermore, accounting standards have been tightened and corporate profits have become more volatile. Also, too many firms have issued more shares to buy another company.
With the United States stock market at near record highs, many investors are taking profits, further depressing share prices.
Perhaps financial engineering has come to the end of the road, and a surging supply of shares will come on to the market, overwhelming the aforementioned factors.
Buy-backs may be only the latest financial manipulation.