Author Topic: Legal Insider Trading is very profitable  (Read 3943 times)

effigy98

  • Bristles
  • ***
  • Posts: 488
Legal Insider Trading is very profitable
« on: June 19, 2018, 07:36:38 PM »
The game is so rigged against slow and steady investors.

A company can plan to buy back a ton of shares without disclosing it until after the event. The executives that know about it can then purchases shares before the company purchases shares which will move the stock price significantly, then the executive can cash out capturing the gain and extracting it from the general public and partially what the company put in. This seems evil and wrong, but is legal and has been put in overdrive from the latest tax cuts.

http://www.brownpoliticalreview.org/2017/11/stock-buybacks-quietly-haunting-american-economy/

FIPurpose

  • Handlebar Stache
  • *****
  • Posts: 1519
  • Location: WA
    • FI With Purpose
Re: Legal Insider Trading is very profitable
« Reply #1 on: June 19, 2018, 08:13:35 PM »
Yep. Funny how raising taxes would be a positive for both wage inflation and actual corporate reinvestment.

gerardc

  • Pencil Stache
  • ****
  • Posts: 767
  • Age: 37
  • Location: SF bay area
Re: Legal Insider Trading is very profitable
« Reply #2 on: June 19, 2018, 08:34:43 PM »
I don't understand why buybacks would increase the stock price. Sure there are less shares available to trade after the buyback, but the company also has less cash assets (that it used to buy the shares) so the remaining shares should keep exactly the same value. Why doesn't that happen?

Wile E. Coyote

  • Stubble
  • **
  • Posts: 249
Re: Legal Insider Trading is very profitable
« Reply #3 on: June 19, 2018, 08:41:02 PM »
I don't understand why buybacks would increase the stock price. Sure there are less shares available to trade after the buyback, but the company also has less cash assets (that it used to buy the shares) so the remaining shares should keep exactly the same value. Why doesn't that happen?

Stocks aren't typically valued solely based on their balance sheet.  They are more commonly valued based upon the earnings that they are expected to generate.  Few shares outstanding means that each remaining share gets a bigger share of the earnings, and thus a higher value.  There is a lot more to it than this, but at least in part, this is why there isn't always a dollar for dollar reduction in the value of a share based upon the reduction in the cash of the company.

gerardc

  • Pencil Stache
  • ****
  • Posts: 767
  • Age: 37
  • Location: SF bay area
Re: Legal Insider Trading is very profitable
« Reply #4 on: June 19, 2018, 08:45:55 PM »
I don't understand why buybacks would increase the stock price. Sure there are less shares available to trade after the buyback, but the company also has less cash assets (that it used to buy the shares) so the remaining shares should keep exactly the same value. Why doesn't that happen?

Stocks aren't typically valued solely based on their balance sheet.  They are more commonly valued based upon the earnings that they are expected to generate.  Few shares outstanding means that each remaining share gets a bigger share of the earnings, and thus a higher value.  There is a lot more to it than this, but at least in part, this is why there isn't always a dollar for dollar reduction in the value of a share based upon the reduction in the cash of the company.

Wouldn't the buyback purchase (an expense) diminish earnings though?

bacchi

  • Walrus Stache
  • *******
  • Posts: 5587
Re: Legal Insider Trading is very profitable
« Reply #5 on: June 19, 2018, 10:33:39 PM »
I don't understand why buybacks would increase the stock price. Sure there are less shares available to trade after the buyback, but the company also has less cash assets (that it used to buy the shares) so the remaining shares should keep exactly the same value. Why doesn't that happen?

Stocks aren't typically valued solely based on their balance sheet.  They are more commonly valued based upon the earnings that they are expected to generate.  Few shares outstanding means that each remaining share gets a bigger share of the earnings, and thus a higher value.  There is a lot more to it than this, but at least in part, this is why there isn't always a dollar for dollar reduction in the value of a share based upon the reduction in the cash of the company.

Wouldn't the buyback purchase (an expense) diminish earnings though?

Earnings remain the same. Assets (=cash) diminish but the EPS increases.

gerardc

  • Pencil Stache
  • ****
  • Posts: 767
  • Age: 37
  • Location: SF bay area
Re: Legal Insider Trading is very profitable
« Reply #6 on: June 19, 2018, 10:52:17 PM »
Seems like a problem with the market then, which is not able to price things correctly considering all available information. This should be possible to arbitrage away...
In the same way that dividends affect the stock price right after they are paid out, so that the final total value doesn't change much, unless the dividend amount itself indirectly reveals new information.

bwall

  • Handlebar Stache
  • *****
  • Posts: 1035
Re: Legal Insider Trading is very profitable
« Reply #7 on: June 20, 2018, 05:46:18 AM »
Tempest in a teapot.

There are very few buybacks that positively affect the stock price. Some have argued, somewhat convincingly, that stock buybacks are just wasted money as the stock later drops below the buyback level and then the company has to re-issue shares at a lower level.

I'm sure that there are short sellers who look for companies to buy back their own stock as a main criterium for going short. So, if an insider is looking for this as a path to wealth, it is fraught with risk.

Scandium

  • Handlebar Stache
  • *****
  • Posts: 2345
  • Location: EastCoast
Re: Legal Insider Trading is very profitable
« Reply #8 on: June 20, 2018, 07:58:17 AM »
then the executive can cash out capturing the gain and extracting it from the general public and partially what the company put in. This seems evil and wrong, but is legal and has been put in overdrive from the latest tax cuts.

How does a company spending it's own cash to buy it's on stock "extract money from the general public"? If the connection is the tax cuts (which your post indicate) the buyback is irrelevant to that. The tax cuts gave corporations more money (stupidly IMO), but how they spend it is a flimsy connection. They could just as well have bought corporate jets or raised CEO salaries, neither of which would be any better or worse. If anything share buybacks at least have a chance to benefit the millions of 401k holders..

effigy98

  • Bristles
  • ***
  • Posts: 488
Re: Legal Insider Trading is very profitable
« Reply #9 on: June 20, 2018, 08:37:16 AM »
The stock price is mostly based on supply and demand over the short term.

Example: I buy a 10 million shares of my own stock without anyone knowing I'm going to do so, it jumps $10. Then people react and buy even more of it thinking something awesome is going on so it goes up further. I then sell a million personal shares for a huge profit. The market reacts and sells it back down to the previous level or worse, and the CEO has now extracted many millions of dollars from the company that would have otherwise stayed in the company. On top of this, they do not use that money for R&D to hire people and buy equipment, its sole purpose is to do this shell game and extract money from investors.

Yankuba

  • Handlebar Stache
  • *****
  • Posts: 1356
  • Location: Long Island, NY
Re: Legal Insider Trading is very profitable
« Reply #10 on: June 20, 2018, 08:41:10 AM »
Tempest in a teapot.

There are very few buybacks that positively affect the stock price. Some have argued, somewhat convincingly, that stock buybacks are just wasted money as the stock later drops below the buyback level and then the company has to re-issue shares at a lower level.

I'm sure that there are short sellers who look for companies to buy back their own stock as a main criterium for going short. So, if an insider is looking for this as a path to wealth, it is fraught with risk.

I have read the opposite. I was under the impression that a significant percentage of recent bull market gains are from buybacks

toganet

  • Stubble
  • **
  • Posts: 239
  • Location: Buffalo, NY
Re: Legal Insider Trading is very profitable
« Reply #11 on: June 20, 2018, 10:56:04 AM »
The stock price is mostly based on supply and demand over the short term.

Example: I buy a 10 million shares of my own stock without anyone knowing I'm going to do so, it jumps $10. Then people react and buy even more of it thinking something awesome is going on so it goes up further. I then sell a million personal shares for a huge profit. The market reacts and sells it back down to the previous level or worse, and the CEO has now extracted many millions of dollars from the company that would have otherwise stayed in the company. On top of this, they do not use that money for R&D to hire people and buy equipment, its sole purpose is to do this shell game and extract money from investors.

My understanding is that this would not be legal for the CEO to do.  The public companies where I've worked the C-suite (and others) would set up SEC Rule 10b5-1 trading plans, and their trade activities are public information.  Are there loopholes, sure -- but at least it's transparent to some degree.

Car Jack

  • Handlebar Stache
  • *****
  • Posts: 1823
Re: Legal Insider Trading is very profitable
« Reply #12 on: June 20, 2018, 12:08:37 PM »
The stock price is mostly based on supply and demand over the short term.

Example: I buy a 10 million shares of my own stock without anyone knowing I'm going to do so, it jumps $10. Then people react and buy even more of it thinking something awesome is going on so it goes up further. I then sell a million personal shares for a huge profit. The market reacts and sells it back down to the previous level or worse, and the CEO has now extracted many millions of dollars from the company that would have otherwise stayed in the company. On top of this, they do not use that money for R&D to hire people and buy equipment, its sole purpose is to do this shell game and extract money from investors.

My understanding is that this would not be legal for the CEO to do.  The public companies where I've worked the C-suite (and others) would set up SEC Rule 10b5-1 trading plans, and their trade activities are public information.  Are there loopholes, sure -- but at least it's transparent to some degree.

Not only that, high executives have to disclose when they are going to make a trade in their own company stock.  I see this with my own company and the CEO, where I know a month ahead of time that he's unloading shares.

Proud Foot

  • Handlebar Stache
  • *****
  • Posts: 1134
Re: Legal Insider Trading is very profitable
« Reply #13 on: June 20, 2018, 12:49:51 PM »
The game is so rigged against slow and steady investors.

A company can plan to buy back a ton of shares without disclosing it until after the event. The executives that know about it can then purchases shares before the company purchases shares which will move the stock price significantly, then the executive can cash out capturing the gain and extracting it from the general public and partially what the company put in. This seems evil and wrong, but is legal and has been put in overdrive from the latest tax cuts.

http://www.brownpoliticalreview.org/2017/11/stock-buybacks-quietly-haunting-american-economy/

Anecdotal, but all the individual stocks I own that have done a stock buy back I have always gotten a notice of the date and share price of the buy back and given the option to sell or keep my shares.

The biggest issue I have with corporate buybacks is they typically are not the best use of the money and a lot of times will be at a price higher than what the stock is currently trading at.

bwall

  • Handlebar Stache
  • *****
  • Posts: 1035
Re: Legal Insider Trading is very profitable
« Reply #14 on: June 20, 2018, 07:31:11 PM »
The stock price is mostly based on supply and demand over the short term.

Example: I buy a 10 million shares of my own stock without anyone knowing I'm going to do so, it jumps $10. Then people react and buy even more of it thinking something awesome is going on so it goes up further. I then sell a million personal shares for a huge profit. The market reacts and sells it back down to the previous level or worse, and the CEO has now extracted many millions of dollars from the company that would have otherwise stayed in the company. On top of this, they do not use that money for R&D to hire people and buy equipment, its sole purpose is to do this shell game and extract money from investors.

The hypothetical CEO could also buy his shares just as a huge short seller is beginning a large short position. Then he'd be stuck in an underwater position with no way to move the stock price up, other than the old fashioned way; increase shareholder value.

bwall

  • Handlebar Stache
  • *****
  • Posts: 1035
Re: Legal Insider Trading is very profitable
« Reply #15 on: June 20, 2018, 07:46:29 PM »
Tempest in a teapot.

There are very few buybacks that positively affect the stock price. Some have argued, somewhat convincingly, that stock buybacks are just wasted money as the stock later drops below the buyback level and then the company has to re-issue shares at a lower level.

I'm sure that there are short sellers who look for companies to buy back their own stock as a main criterium for going short. So, if an insider is looking for this as a path to wealth, it is fraught with risk.

I have read the opposite. I was under the impression that a significant percentage of recent bull market gains are from buybacks

https://www.cairn-int.info/article-E_REL_744_0479--the-quest-for-shareholder-value-stock.htm

It's a bit of a long read, but it explains quite a bit. Here's a passage that brings it into focus, IMHO:

"Lehman Brothers repurchased $2.6 billion in 2007, and $16.7 billion over 2000-2007. In April and June 2008, in contrast, Lehman did two $4 billion stock issues. Meanwhile, like the other Wall Street banks, Lehmanís stock price had dropped sharply from early February 2008, when the severity of the subprime mortgage crisis became widely known. On February 2, 2008, Lehmanís stock price stood at $65.55, but on September 12, 2008 closed at $3.65. The following Monday the company entered into bankruptcy (Bel Bruno 2008; Rizzo and Bel Bruno 2008). Clearly, the $16.7 billion in stock that Lehman had repurchased since 2000 had failed to deliver long-term shareholder value."

So, Lehman literally pissed away $16.7 billion on stock in eight years. If they'd kept the money in the till, perhaps they could have staved off bankruptcy. Oh well, too late now to cry over spilled milk.

FIPurpose

  • Handlebar Stache
  • *****
  • Posts: 1519
  • Location: WA
    • FI With Purpose
Re: Legal Insider Trading is very profitable
« Reply #16 on: June 20, 2018, 07:53:06 PM »
I guess they did the best thing that they could have done for their stock holders. Buy them out, and save them from the bankruptcy.

Bicycle_B

  • Handlebar Stache
  • *****
  • Posts: 1816
  • Mustachian-ish in Live Music Capital of the World
Re: Legal Insider Trading is very profitable
« Reply #17 on: June 21, 2018, 09:28:31 AM »
The stock price is mostly based on supply and demand over the short term.

Example: I buy a 10 million shares of my own stock without anyone knowing I'm going to do so, it jumps $10. Then people react and buy even more of it thinking something awesome is going on so it goes up further. I then sell a million personal shares for a huge profit. The market reacts and sells it back down to the previous level or worse, and the CEO has now extracted many millions of dollars from the company that would have otherwise stayed in the company. On top of this, they do not use that money for R&D to hire people and buy equipment, its sole purpose is to do this shell game and extract money from investors.

The description above is basically a pump and dump scheme. From general reading of business news, it appears to me that most stock buybacks ("most" in dollar terms) are not spent in this way.

Most companies do not just do a buyback once, then collapse in stock price a month or later, permanently screwing the investors. The article pointed out that Lehman did buybacks and then went broke in the financial collapse... but how many S&P 500 companies did that? Aren't the vast majority of the firms on the S&P ten years ago still in business, even though many of them did buybacks? Aren't most of them far higher now than then, despite buybacks before the crash and in recent years? Pump and dump is bad, but normal stock buybacks probably aren't.

As I understand it, the rational business case for a stock buyback depends on the company having good reason to believe that its stock is underpriced, and also having no better way to invest the cash that is spent on the buyback. Both of those conditions can occur, and if they do, all of the company's existing stockholders will benefit from the purchase.

The linked article mentions that companies that did stock buybacks were outperformed by companies that did not do them. If buybacks are being done on the up and up, meaning purely for good business reasons (not pump and dump), then arguably that is exactly what should happen. Companies with a better way to invest their money inside the company should invest internally, making the company grow. By definition, these companies have better opportunities in the first place. The buybacks didn't cause the difference, they just responded to it.

To be fair, it's possible that neither argument is correct. The small difference quoted in the article might be temporary, and would not appear if a different measurement timeframe were chosen. In other words, saying that companies which do buybacks are worse performers may not be accurate anyway in the long term. If it were accurate, investors ought to just avoid companies that do buybacks. I haven't seen consistent support for that strategy. But once it became popular, stock prices would compensate for it anyway, in which case new investors would break even.

In any case, if the companies that did the buybacks did them correctly, their shareholders all made extra profits due to the buyback decision. Remember that the company's stock was underpriced in the first place. If it wasn't, the right decision for a company that has more cash than it can invest in core business activities is to just declare a dividend. If the share price of company is low, though, buying its own stock is better than a dividend, because the future returns are higher.

You can argue that most buybacks are pump and dump actions by evil executives, not rational pro-shareholder actions by responsible executives. But you should find evidence for that. The article linked doesn't provide it.
« Last Edit: June 21, 2018, 09:43:52 AM by Bicycle_B »

effigy98

  • Bristles
  • ***
  • Posts: 488
Re: Legal Insider Trading is very profitable
« Reply #18 on: June 21, 2018, 12:47:20 PM »
Discussed today on the KR near 1 minute mark... timing.

https://www.youtube.com/watch?v=-DLrk-BiV0I

Summary is when a company says they are buying back shares because the share price is cheap, you can make a profit buy buying some puts in the majority of cases because the insiders are about to dump. This should not be legal, but it is.
« Last Edit: June 21, 2018, 12:52:31 PM by effigy98 »

Bicycle_B

  • Handlebar Stache
  • *****
  • Posts: 1816
  • Mustachian-ish in Live Music Capital of the World
Re: Legal Insider Trading is very profitable
« Reply #19 on: June 21, 2018, 02:02:58 PM »
I listened from 1 minute to about 2 minutes. Discussion at that point did not say you can make a profit, it said prices rise after buyback announcements. I don't know whether you can react fast enough as a short term trader to profit off such an announcement or not, but short term effects are mostly irrelevant to slow and steady investors. Your OP's apparent thesis statement was the market is rigged against slow and steady investors. Why are you now discussing short term trades?

A long term investor should be proof against these things anyway. A buyback announcement's effect will soon fade unless real purchases back it, and real earnings by the company sustain it. I don't see that the SEC study as quoted suggests any change in behavior by slow steady investors.

effigy98

  • Bristles
  • ***
  • Posts: 488
Re: Legal Insider Trading is very profitable
« Reply #20 on: June 21, 2018, 02:44:31 PM »
Because this money is getting sucked out of the share price like a fee or a tax to long term holders. Shares that would not be sold otherwise without the manipulation. This money does not just funnel back into the stock price magically out of nowhere.

If I were to buy a penny stock, then post 100's of articles everywhere on how this company just cured cancer, it runs up 100's of dollars, then sell it... That would be illegal. At the same time it is ok for company executives to say we are buying back billions in stock, stock price jumps, then sell their shares, and then never actually do the buyback. That sucks money out of longterm investors gains.
« Last Edit: June 21, 2018, 02:49:21 PM by effigy98 »

Bicycle_B

  • Handlebar Stache
  • *****
  • Posts: 1816
  • Mustachian-ish in Live Music Capital of the World
Re: Legal Insider Trading is very profitable
« Reply #21 on: June 21, 2018, 07:13:58 PM »
So the problem is announcements that don't get followed up by buybacks?

I bought funds in 1995 that I still hold. Suppose that an exec in one of the companies in such a fund does a buyback announcement like you describe. Shares like the ones held by my fund suddenly trade hands at a higher price than before the buyback. The money comes from a new purchaser, and is received by someone who already owns shares. The company's operations and profitability are unchanged. The price of the shares in my own fund goes up. How did I lose?


smallstache

  • Stubble
  • **
  • Posts: 144
Re: Legal Insider Trading is very profitable
« Reply #22 on: June 21, 2018, 07:26:35 PM »
Yep. Funny how raising taxes would be a positive for both wage inflation and actual corporate reinvestment.

You will have to explain this.

FIPurpose

  • Handlebar Stache
  • *****
  • Posts: 1519
  • Location: WA
    • FI With Purpose
Re: Legal Insider Trading is very profitable
« Reply #23 on: June 21, 2018, 08:04:13 PM »
Yep. Funny how raising taxes would be a positive for both wage inflation and actual corporate reinvestment.

You will have to explain this.

Higher taxes will cause companies to make more decisions that lower their tax liability.

When taxes are low is it better for investors to collect their profits, when taxes are higher, it is more advantageous to investors for companies to reinvest in new projects or better employees and increase company value since it keeps actualized profits lower.

Lower taxes do not provide wage growth, they only provide an opportunity for investors to quickly eat their profits before taxes go back up again.

SubL stache

  • 5 O'Clock Shadow
  • *
  • Posts: 74
Re: Legal Insider Trading is very profitable
« Reply #24 on: June 21, 2018, 08:04:40 PM »
Way too much misinformation in here.

smallstache

  • Stubble
  • **
  • Posts: 144
Re: Legal Insider Trading is very profitable
« Reply #25 on: June 23, 2018, 09:26:04 PM »
Yep. Funny how raising taxes would be a positive for both wage inflation and actual corporate reinvestment.

You will have to explain this.

Higher taxes will cause companies to make more decisions that lower their tax liability.

When taxes are low is it better for investors to collect their profits, when taxes are higher, it is more advantageous to investors for companies to reinvest in new projects or better employees and increase company value since it keeps actualized profits lower.

Lower taxes do not provide wage growth, they only provide an opportunity for investors to quickly eat their profits before taxes go back up again.

I'm not buying this at all.

FIPurpose

  • Handlebar Stache
  • *****
  • Posts: 1519
  • Location: WA
    • FI With Purpose
Re: Legal Insider Trading is very profitable
« Reply #26 on: June 24, 2018, 08:22:23 AM »
Economist article showing that tax cuts are not corolated with wage increases:

https://www.economist.com/finance-and-economics/2017/10/26/will-corporate-tax-cuts-boost-workers-wages

If you've already used your economist article for the day:

https://aneconomicsense.org/2017/10/18/lower-corporate-taxes-have-not-led-to-higher-real-wages/

This means that you have to treat wages just like any other commodity in the market, and since employee pay is a fully-justified business expense: it will be de facto cheaper to risk for that extra project or to hire the better talent, to go ahead and give higher offers to attract the talent that you want.

Do we have enough info to prove this theory of mine. No. But like everything else in the economy there are 100,000 factors that have to be included as well. I'm sure there are economic conditions where what I'm saying is wrong, and there are economic/polictical conditions where it is right.