Voltaire, you are semi-correct, but have made some errors in you comments. First, options are nearly always immediately converted to shares and sold for tax reasons (avoidance of alternative minimum tax). In any case, companies are now required to report shares outstanding on a fully diluted basis which assumes full conversion of all outstanding options. So the problem is not in the denominator.
The real problem is in the numerator. The reason is that there is a cost to issuance of options, and this cost does not appear on the income statement. So what happens is that income (without a provision for the cost of issuing stock options to top management) is divided by fully diluted shares.
There is nothing wrong with stock buybacks -- as Geoff, TCB and others have pointed out they are really surrogates of dividends. The problem is with the people who focus on eps and inflated eps growth as a result of buybacks, because these buybacks create a leverage which most people don't understand.
For those who would like to play with a simple example, suppose that a company in year 0 has earnings of $100 MM with 100MM shares o/s. Now in year 1 it earns $115 MM, but during the course of the year it reduce the number of shares o/s to 92 MM, so now earnings are $1.25 per share. So while the company as a whole is growing its earnings at 15%, eps appears to be growing at 25%. In theory, what ought to be happening is that the share price should not change. The reality is that some investors view share buybacks not as surrogates for dividends (in which case the share price would remain constant), but as a sign that management believes the stock to be undervalued.
TTFN,
CTC |
