Saturday, September 19, 2009

Buy High, Sell Low

If you want a good example of how overconfidence leads to mistakes (and very expensive ones at that), check out Floyd Norris's column in today's New York Times. Usually, we see overconfidence at work in individual errors; here, we see it at work on the corporate level.

Norris's column focuses on the allure created when publicly traded companies buy back their own stock (parenthetical comments below are my own):

"One reason investors have viewed buybacks as a positive was that they indicated corporate management and boards were confident (there's that word!) that their share prices were low and that the company would not need the cash for a possible downturn in business.

"Unfortunately," Norris concludes, "there is little evidence that is the case."

Records show that companies typically buy their own stock at the top of the market -- a colossal waste of money. He cites the case of American International Group. In 2007 it spent $6 billion buying back its own stock. In the first quarter of 2008, it spent another $1 billion. And then? Ka-boom. The bottom fell out of the market. Today, AIG would be broke without a massive federal bailout.

And AIG is no exception. Home Depot did the same thing. In the third quarter of 2007, Norris reports, it bought $10 billion of its own stock at an average price of $37 a share. By early this year, the price had fallen to $18. You talk about do-it-yourself investing!

Yessir, Home Depot: You can do it. We can help. Next time, just hang onto the cash.

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