David Prosser: The distorting impact of share buy-backs


Outlook Terry Smith is best-known these days as the chief executive of Tullet Prebon, the giant inter-dealer broker. It is often forgotten that Mr Smith first came to prominence in 1990, when he published Accounting for Growth, a book in which he revealed a string of accounting tricks through which companies had been pulling the wool over shareholders' eyes about how they were performing.

The book is well worth reading to this day and you won't need an accounting qualification to understand it. Equally, it's still worth listening to what Mr Smith has to say on the subject of accounting tricks – like the paper he published yesterday on share buy-backs.

Investors, broadly speaking, are fond of buy-backs. If a company has cash on its balance sheet for which it can't find a use, why shouldn't it be distributed among shareholders?

To which the answer is no reason at all, as long as the buyback process doesn't then distort investors' view of the company. Mr Smith's view is that on current accounting rules, it does. The effect of taking the shares bought off the balance sheet is to give an artificial boost to a company's earnings per share (earnings stay the same, the number of shares falls). Since the earnings per share ratio is one of the key yardsticks that investors look at when judging performance, that seems perverse.

What's the solution? Well, in an ideal world, one would change the accounting rules to counter the problem. But until that happens, this is a useful lesson for investors. Think carefully about the impact of share buy-backs – particularly, as Smith points out, where companies use eps as a basis for setting bonuses for senior executives.

PROMOTED VIDEO
Arts and Entertainment
tv
News
video
News
people
Arts and Entertainment
Jimson Weed/White Flower No 1 by Georgia O'Keeffe
art
Sport
Robin van Persie leaves the field at the King Power Stadium last Sunday
football
Arts and Entertainment
tvPresenter back after daughter's Halloween accident
Arts and Entertainment
Martin Freeman and Benedict Cumberbatch as John Watson and Sherlock Holmes in Sherlock
tv

Co-creator Mark Gatiss dropped some very intriguing hints ahead of the BBC drama's return next year

News
people

London 'needs affordable housing'

News
ebooksNow available in paperback
News
In this photo illustration, the Twitter logo and hashtag '#Ring!' is displayed on a mobile device as the company announced its initial public offering and debut on the New York Stock Exchange on November 7, 2013 in London, England. Twitter went public on the NYSE opening at USD 26 per share, valuing the company's worth at an estimated USD 18 billion.
news

Arts and Entertainment
Timeshift: The Ladybird Books Story (9pm BBC4 Sun 22 Dec)
BooksLadybird drops branding books for boys and girls
Arts and Entertainment
music Band accidentally drops four-letter description at concert
News
news
Life and Style
tech
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Reach Volunteering: Trustee – PR& Marketing, Social Care, Commercial skills

Voluntary Only - Expenses Reimbursed: Reach Volunteering: Age Concern Slough a...

Reach Volunteering: Charity Treasurer

Voluntary Only - Expenses Reimbursed: Reach Volunteering: Crossroads Care is s...

SThree: Trainee Recruitment Consultant - Soho

£20000 - £25000 per annum + OTE £35,000: SThree: We consistently strive to be ...

Ampersand Consulting LLP: Markit EDM (CADIS) Developer

£50000 - £90000 per annum + benefits: Ampersand Consulting LLP: Markit EDM (CA...

Day In a Page

US immigration: President Obama ready to press ahead with long-promised plan to overhaul 'broken system' - but will it get past a Republican-controlled Congress?

Immigration: Obama's final frontier

The President is ready to press ahead with the long-promised plan to overhaul America's 'broken system' - but will it get past a Republican-controlled Congress?
Bill Cosby rape allegations explained: Why are these allegations coming out now? Why didn’t these women come forward earlier? And why has nobody taken legal action?

Bill Cosby rape allegations explained

Why are these allegations coming out now? Why has nobody taken legal action? And what happens next for the man once thought of as 'America's Dad'
Four years of excruciating seizures caused by the 1cm tapeworm found burrowing through a man's brain

You know that headache you’ve got?

Four years of excruciating seizures caused by the 1cm tapeworm found burrowing through a man's brain
Travelling to work by scooter is faster than walking and less sweaty than cycling, so why aren’t we all doing it?

Scoot commute

Travelling to work by scooter is faster than walking and less sweaty than cycling, so why aren’t we all doing it?
Paul Robeson: The story of how an American icon was driven to death to be told in film

The Paul Robeson story

How an American icon was driven to death to be told in film
10 best satellite navigation systems

Never get lost again: 10 best satellite navigation systems

Keep your vehicle going in the right direction with a clever device
Paul Scholes column: England must learn to keep possession and dictate games before they are exposed by the likes of Germany and Brazil

Paul Scholes column

England must learn to keep possession and dictate games before they are exposed by the likes of Germany and Brazil
Michael Dawson: I’ll thank Spurs after we win says defender as he prepares to return with Hull

Michael Dawson: I’ll thank Spurs after we win

Hull defender faces his struggling former club on Sunday ready to show what they are missing. But he says he will always be grateful to Tottenham
Frank Warren column: Dr Wu has big plans for the professionals yet he should stick to the amateur game

Frank Warren column

Dr Wu has big plans for the professionals yet he should stick to the amateur game
Synagogue attack: Fear unites both sides of Jerusalem as minister warns restoring quiet could take 'months'

Terror unites Jerusalem after synagogue attack

Rising violence and increased police patrols have left residents of all faiths looking over their shoulders
Medecins sans Frontieres: The Ebola crisis has them in the headlines, but their work goes far beyond West Africa

'How do you carry on? You have to...'

The Ebola crisis has Medecins sans Frontieres in the headlines, but their work goes far beyond West Africa
Isis extends its deadly reach with suicide bombing in Kurdish capital

Isis extends its deadly reach with suicide bombing in Kurdish capital

Residents in what was Iraq’s safest city fear an increase in jihadist attacks, reports Patrick Cockburn
Underwater photography competition winners 2014 - in pictures

'Mysterious and inviting' shot of diver wins photography competition

Stunning image of cenote in Mexico takes top prize
Sir John Major: Negative West End portrayals of politicians put people off voting

Sir John Major hits out at theatres

Negative West End portrayals of politicians put people off voting
Kicking Barbie's butt: How the growth of 3D printing enabled me to make an army of custom-made figurines

Kicking Barbie's butt

How the growth of 3D printing enabled toy-designer to make an army of custom-made figurines