“…businesses are normally seen as passive capital-raisers, not active market participants and certainly not market disciplinarians. Even though they can act on perceived mispricings, firms typically focus more on expanding their own business than on searching for alpha. Bosses have operational backgrounds. They are more fluent in capital spending than capital markets. And when financial officers do wade into the market—to issue or buy back shares, for example—valuation is just one of many considerations, alongside avoiding taxes, ensuring a healthy credit rating and making sure the firm does not take on too much leverage.
And yet a growing body of work suggests that corporations, far from being passive observers, are some of the market’s most effective arbitrageurs. In 2000 Malcolm Baker of Harvard University and Jeffrey Wurgler, then of Yale University, found a tight connection between firms’ net equity issuance and subsequent stockmarket returns. Years in which companies issued relatively more stock were typically followed by weaker market performance. More tellingly, companies seemed to issue precisely when valuations were rich, and especially when other frothy signals, such as buoyant consumer sentiment, were drawing attention.
Timing the market is impressive; out-trading the professionals is even more so. Yet firms that issue or retire their own shares routinely do exactly that. In 2022 David McLean of Georgetown University and co-authors showed that corporate-share sales and buy-backs forecast future returns more accurately than the trades of banks, hedge funds, mutual funds and wealth managers.
What explains this prowess? Part of the answer lies in firms’ access to private information. Few are better placed to forecast a company’s future cashflows than insiders. When a company begins buying back its own shares—or employees convert their options into stockholdings—investors should pay attention.”
It then goes on to elaborate the companies’ advantages against institutional investors, which makes them the world’s best investors.
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