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Morgan Stanley Unchained on Buyback Talk

Better dividends are ideal, but progress is progress


Morgan Stanley (NYSE:MS) might ask the Federal Reserve for permission to resume its share repurchase program, buying back its own stock for the first time since 2008 when the financial crisis made capital preservation a matter of life or death.

The white-shoe Wall Street investment bank could make the request as early as January as part of the Fed’s annual stress test, The Wall Street Street Journal reports. MS shares popped on the news; a resumption of its long-shelved capital plan likely would offer some more upside ahead.

But we tend to prefer dividends to share buybacks here at InvestorPlace, if only because most companies are so boneheaded about repurchases, buying back their own stock when it’s expensive, not cheap. As InvestorPlace contributor Will Ashworth notes about the rush to buybacks:

“The unfortunate part of this herd-like mentality is that CFOs are terrible at estimating the intrinsic value of their share price and thus tend to overpay.”

True, Morgan Stanley’s stock trades at a discount to its own book value, suggesting shares are cheap on some intrinsic level. But then, all banks go for less than book value these days … so it’s hard to say that Morgan Stanley is some standout bargain.

Ashworth continues:

“Companies don’t know how to buy back their shares at prices significantly lower than the intrinsic value. If they did, the early part of 2009 would have seen the busiest trading in the history of the markets. Of course, we know that didn’t happen.”

Indeed, that’s why Warren Buffett always warns shareholders in Berkshire Hathaway (NYSE:BRK.A, BRK.B) that if they sell shares to him in a stock buyback program, well, they’re going to get scalped. The Oracle of Omaha makes it abundantly clear that Berkshire doesn’t buy back shares unless it thinks they are intrinsically undervalued — and in every trade, there can be only one winner.

That said, buybacks do have an advantage over dividends, if only because dividends get taxed twice — once as corporate profits and then again as dividend income. With taxes on dividends set to rise, you can understand why some investors would rather have corporations boost earnings per share (and hopefully share prices) by reducing the number of shares outstanding.

There’s also the case to be made that what’s good for the gander is good for the goose.

Sure, we’d like to see a better yield on Morgan Stanley’s dividend than the currently uncompetitive rate of 1.2%. Hell, “risk-free” 10-year Treasury notes currently throw off 1.65%. And Goldman Sachs‘ (NYSE:GS) dividend yields 1.7%.

But buybacks are what’s driving the bull market in stocks, not retail and institutional investors, according to the well-regarded president of Yardeni Research, Ed Yardeni, who called the market’s intraday bear-market bottom of 666 on March 6, 2009.

“The Fed’s Flow of Funds data show that net issuance of corporate equities over the past year through Q3 was minus $274 billion,” Yardeni writes in a new note to clients. “In other words, buybacks well exceeded gross issues.”

A vast reduction in supply — not increased demand — is what’s boosting the equity market, by Yardeni‘s reckoning. This chart, courtesy of Yardeni Research, does show that buybacks have gone vertical since 2009 — just like the S&P 500:

Again, we generally tend to prefer dividends to buybacks, higher taxes ahead on those payouts notwithstanding. But the fact that Morgan Stanley might be restarting its repurchase program does bode well for its share-price performance, at least in the shorter-term.

And if MS does get the Fed’s green light to restart a buyback, the increased confidence in its financial health is ultimately a bullish sign, too.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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