Shouldn’t they invest that money in products and services to better serve their customers?
Ric Edelman: I've just got one question for you. Why on earth is the stock market so calm? You'd think that investors would be spooked. We've got soaring inflation, rising interest rates, rising tax rates, countries around the world and massive debt, including, by the way, the US (we've added trillions to our debt in the past two years fighting COVID), the supply chain problems that are rampant around the world, and of course the Russian invasion of Ukraine and COVID. Both still here, both still unpredictable. Can companies generate the profits that they need to keep the stock market happy? Well, pretend you're the CEO of a Fortune 500 company. Your job is to get the stock price to rise, to keep shareholders happy so you can keep your job. The best way to get the stock price to rise is to increase your profits, build your business, sell more product, make more money. Investors will reward you by buying your stock, and demand for your stock will make the stock price go up. But what if the economy is getting in your way? Consumer buying is sluggish; takes years to launch a new product. You've got more competition, rising interest rates and inflation, meaning your cost of doing business is higher than ever. You might not be able to increase your sales, or your profits and your stock price might fall. So what can you do about this? Well, the good news is you're sitting on a lot of cash. Your company's made a lot of money over the past decade and you're flush with cash. And I'm not pretending here. This is not some theoretical conversation. The 500 companies that are in the S&P 500, they are collectively sitting on $3 trillion of cash. Now, you got some of that...you're one of these CEOs. What would you do with your share of all that money? Well, you've got three choices. You can buy other companies. And last year, that's exactly what you did last year. Companies did $6 trillion in mergers and acquisitions. So you've pretty much bought everything you want to buy. Or you could try this: you could give your shareholders a dividend. You're sitting on hundreds of billions of dollars. Send the money back to your shareholders. But that's just a one-time event. It won't do you any good long-term, and you're not going to be rewarded with a higher stock price. So here's the third thing you can do: invest the money. Where? Invest it into stocks. Okay. Well, what stocks are you going to buy? Of all the companies in the S&P 500, which company's stock price is lowest and has the best opportunity to rise? Well, CEOs of the S&P 500 have been asking themselves this question, What should they do with all their cash? And guess what they've decided? They've all decided that the best thing they can do with their money is to invest it into the stock market.
Stock Buybacks as a Way to Keep the Stock Price High
Ric Edelman: And guess what stock they've all decided to buy? Their own. Companies in the S&P 500 are buying $319 billion of their own shares this year. Union Pacific is going to spend $25 billion on its own stock. Pepsi and Amazon are each spending $10 billion to buy their own shares. Colgate-Palmolive and Best Buy are spending $5 billion apiece. The average stock in the Russell 3000 has lost more than 30% so far this year. Stocks are cheap. How can it be that every company is decided that their stock is better to buy than any of the other 499 stocks in the S&P 500? You could call this home-team bias. That's a very common psychological error, but it's more treacherous than that. The CEO's compensation, the bonus that the CEO gets is based not on how much profit the company earns. His bonus is based on how high he can get the stock price to be. The stock price is based on supply and demand. And if he can't increase the demand, if he can't convince you to buy more shares, then he'll simply reduce the supply by buying shares back, billions of dollars’ worth of them. Taking those shares off the market - there's a lower supply and that makes the stock price higher. Other investors see what the CEO's doing and they say, Golly, if that company is buying back their own shares, they must believe the shares are a good investment.
Making Sense of Stock Splits from Tesla, Alphabet, and Amazon. Who’s Next?
Ric Edelman: They must believe the price is low and this increases demand at the very moment that supply is smaller. Again, the price goes up and you do all this, as your CEO, without improving the business. You didn't create a better product; you didn't increase sales; you didn't generate more profit. You simply took your own money and bought your own shares of stock. This is nothing but gamesmanship. And after you do that, after the excitement wears off, you're going to be right back where you are today. What will be your next trick? A stock split. Tesla, Alphabet (which owns Google) and Amazon, they've all announced stock splits. You know, a stock split is nothing but playing with math. There's no impact on the value of the company. Tesla rose 8% on the news anyway. Why? I mean, it makes no sense. Alphabet rose 7.4% when they announced a stock split. Amazon announced a stock split. The stock went up over 5%. Makes no sense because a stock split doesn't have any mathematical impact. Let me help you understand. Let's say you have 100 shares of stock at $10 a share. Grand total was $1000. Then you do a two for one stock split. Well, that means you now have 200 shares, not 100. But instead of being $10 a share, they're only $5 a share. Remember, 200 shares at $5/share is $1000. Just like 100 at $10, that's $1000 as well. It's just playing with math. There's no economic impact, nothing changes in the company. But investors love stock splits. They think it means that, oh, the price was $10, it's going to go down to $5 and they're going to get the price back up to $10, but now I have twice as many shares. It's a gimmick.
The Emergence of Fractional Shares
Now, in the old days, companies used to say that they had to do stock splits because as they grow in profits, their stock prices rose. And as the stock prices rose, the price got too high for people to be able to afford to buy the shares. So they did a split to bring the share price back down, making it more affordable for investors. That made sense in the 1970s, but it doesn't make any sense today. Today at Charles Schwab, you can buy fractional shares. You can buy a piece of a stock for just $5. So the company doesn't need to do a stock split to make the shares affordable for you to buy them. Schwab makes every stock completely affordable for every investor, and Schwab does it commission-free. Stock splits and stock buybacks are games that corporate CEOs play to trick investors into buying their shares. When you see companies playing these games, spending more time trying to figure out how to prop up the stock price instead of trying to actually, you know, grow their company... You know there's something wrong going on underneath the surface. Don't get excited by stock buybacks and stock splits. Instead, you should get worried about the overall health of the stock market and the overall US economy.