Professor Elam

Monday April 5 2010

The reason I write the blog is to supplement the textbooks with the context of the real business world. 

We are beginning our study of the equity section of the balance sheets. A few years back Eddie Lampert was hailed as the next Warren Buffet. He recognized the real estate value of KMart and bought their stores out of bankruptcy. He then managed to snare Sears and formed SHLD, Sears Holdings. The idea was lots of cash flow which would finance other brilliant purchases. 

Now the reality. Read the link to see that he has spent % billion since buying the company in share buybacks rather than investing in the stores. Earth to Wall Street, this guy is a hedge fund manger, not a retailer. 

The share price zoomed after he formed the new company, he was hailed as a financial genius, by Business Week no less, usually a sign of impending doom, the stock peaked at 200, then reality set in. It was clear that he was not putting money into improving the stores against other hard chargers like Target or JCP, and so amid the stock crash, the shares went back to near $20. Now, why would he spend that kind of money, $5 B, to buy shares in a company he already owns?

The answer is in the arithmetic of earnings per share. If the number of shares decrease, then the earnings per share increase, the total earnings are spread across fewer shares raising the EPS. The performance of SHLD does not have to improve, this is mere financial manipulation to make things appear better. The result is that despite his critics, the share price has risen. Just looking at the chart, I would guess 120 will be serious resistance. 

Most companies buy shares back to keep the number fairly constant. Here the idea is to decrease the number of shares outstanding.