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CARDIFF GARCIA, HOST:
Hey, everyone. This is THE INDICATOR FROM PLANET MONEY. I'm Cardiff Garcia. And this is Finance Fridays With Mary, our third installment of these episodes in which my friend Mary Childs, the finance reporter at Barron's, answers our listener questions about all things to do with the financial sector.
Mary, welcome back.
MARY CHILDS: Hi. Thank you.
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GARCIA: So this is a snack-sized episode.
GARCIA: Right? - or three questions, three bite-sized answers.
CHILDS: We had all these questions that we thought were very good questions and warranted answering, but the answers weren't long enough to be, like, a whole segment. And so we're just going to snack on them. We're just going to get - do quick little answers.
GARCIA: I think it's just because you're so smart that you're able to dispatch these questions really quickly.
CHILDS: Like, I'm up at bat and I'm like, just bring them up, you know? Like...
GARCIA: I'll be honest. It made me a little hungry, though.
CHILDS: I have a York Peppermint Patty in my bag. Do you need it?
GARCIA: I do, actually. I'm going to eat it during the ad break. And when we come out of the ad break, I will be satiated. And Mary will start answering questions from our listeners.
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CHILDS: Don't touch it. You ate the whole thing?
GARCIA: Yeah. What?
CHILDS: Did I not just say to split that with me?
CHILDS: So this is the episode where Cardiff steals the snacks.
GARCIA: Yes. Delicious. OK. Listener questions for Mary - let's go.
TOM DIXON: Hello. This is Tom Dixon from Eagan, Minn. Your Finance Fridays got me re-wondering about a question. Why are public companies so fixated on their share prices? Are they actually out in the marketplace selling additional shares to generate cash?
GARCIA: So we should actually break down the question a little bit. So public companies - these are companies that trade on stock exchanges, so you can buy their shares. And when a company's shares go up, it's obviously good if you own those shares. But also, it might tempt the company to issue new shares because they can get a lot of money from it, right?
CHILDS: Right. So that's the fundamental purpose here - is a company wants to sell new slices of ownership in itself so that it can go fund doing something awesome like buying another company or pouring money into research and development, building a new plant - any of these things that requires money. They can go out and sell more shares and...
GARCIA: New shares that did not exist before.
CHILDS: Correct. So they had, you know, a pool of shares outstanding. And they're just going to add more to the pool, which means if you're an existing shareholder, you're kind of on the losing end of this because suddenly, the party that you attended - it was just, like, a hundred of you. It just got a lot more crowded.
GARCIA: Yeah, and so now you have to split your ownership of the company with more people, which means your little slice of the ownership is worth a little bit less.
CHILDS: Basic economics - there is more supply.
GARCIA: OK. And Tom's question was about the idea that, once a company's shares go up, that company will be more likely to issue more shares because it can raise money. How often does that happen - these follow-on share offerings?
CHILDS: So last year, American companies raised $143 billion in these types of follow-on offerings...
GARCIA: Sounds like a lot.
CHILDS: ...Which is kind of insane because especially - you compare that with initial public offerings, where a company isn't public and then they go public. And that only raised $54 billion last year.
GARCIA: So it's actually a lot more, and hardly anybody talks about it.
CHILDS: I think we just get so excited about IPOs because it's like a new...
GARCIA: It's a brand new thing.
CHILDS: Fresh meat - yay. I don't know. Those figures are according to PWC.
GARCIA: OK. Great answer, Mary.
CHILDS: Thank you so much. I did a lot of work on that - diligence.
GARCIA: Next question is from listener Chris.
CHRIS PEELE: This is Chris Peele from Santa Clara, Calif. Do you think that people in finance are inclined to fall victim to a self-serving bias that leads them to think that their success is due to their own hard work when it's more due to external factors like luck?
GARCIA: What do you think?
GARCIA: Yes. They are inclined to fall to self-serving bias where they attribute all their success to their brilliance and genius and hard work and not to other things like circumstances or luck.
CHILDS: I think there are a lot of people that don't see, perhaps, all of the very many things that went into their own successes, and that's a normal, human thing. I think we all do that.
GARCIA: Yeah. Of course, this happens to people in the financial sector just because they are people. This is something that happens to all of us. We tend to, like, look at people...
GARCIA: ...Around the world, and we say, well, their success is a result of, like, luck and all these other things. But for us, we like to believe it's our own talent and genius.
CHILDS: Right. And there's this debate in the market as to whether confidence can actually help or hurt you because sometimes, you do have to really fully believe in yourself and the trade that you're putting on in the market when no one else will. Sometimes, you have...
GARCIA: Sometimes, you, like - you buy a stock, and everybody hates it. And it's going down, and you're like, no. This thing is going to go up.
CHILDS: Right. And you can be wrong for a long time and you might be losing money for a long time. Like, for example, there was this hedge fund manager Michael Burry who, before the financial crisis, knew that housing was doomed. And this is actually all in Michael Lewis's book "The Big Short." He was super sure he knew it. He put on all his bets, but he was really early, and housing kept going up. And he was, like, just sitting there short, just betting against it, waiting for it to do down.
GARCIA: Everybody's like, what are you doing, dude?
CHILDS: Right. It looks really bad for a long time, and it's not clear at that point. You know, the thing hasn't happened yet, so he could just be wrong and have lost a ton of money. Of course, as we now know, the housing market did indeed fall. He made a ton of money. He was proven super correct, but that confidence served him really, really well to get through the kind of tough period where the market was going against him.
GARCIA: Right, but not everybody is a Michael Burry, to be clear.
CHILDS: For every real Michael Burry - actual hedge fund manager with an inside actual trader who knows something and is really confident and got it - there are, like, 99 to a million people who really think they got it but don't actually got it.
GARCIA: That's quite a range, right?
CHILDS: I don't want to put too fine a point on it.
GARCIA: There's very few people who are Michael Burry. A lot of people put on bets, and everybody goes against them. And there's a good reason...
GARCIA: ...That everybody's going against them. Those people are just going to end up losing their money.
CHILDS: Right. They're just wrong, it turns out.
GARCIA: Got it. OK. Next question comes from listener Darren, who did not send us his audio file, so producer Rachel Cohn is going to read it in her best Darren voice, I guess. Why not?
RACHEL COHN, BYLINE: Hi. It's me, Darren. I want to know - how do shareholders benefit from share buybacks? Why would shareholders prefer an action that could increase stock prices but is not guaranteed to a dividend that is real cash in a shareholder's hand? Thank you.
GARCIA: OK. First of all, we should explain what a share buyback actually is, Mary.
CHILDS: Oh, that's when a company buys back some of its shares.
GARCIA: And the way this works is that a company might have a bunch of cash, right?
CHILDS: And they're not sure what to do with it.
GARCIA: They're not sure what to do with it. And they see that, in the market, the shares of that company are underpriced, they think. The managers of the company are like, wait a minute. Why are our shares trading for so cheap? We should use the company's own cash to buy back those shares.
CHILDS: That's right. And so they go into the market, and they just kind of zoop (ph) up their own shares, which has the effect of reducing kind of the overall number of outstanding shares, which means that the ones out there that are left are worth more because you're still kind of owning that same slice of the company.
GARCIA: Yeah, because you end up owning, like, a bigger piece of the company if you keep your shares after those other shares are hoovered up.
GARCIA: OK. So if you own shares of a company and the company does a share buyback, the value of your shares will go up, so yay. But Mary, the second part of listener Darren's question is, why, if you are a shareholder, would you prefer that a company do a share buyback instead of just offering a dividend, which is when a company, essentially, just gives cash directly to shareholders? So to be clear, the idea here is that this company has all this extra cash. But rather than buying its shares back, why not just give out that cash?
CHILDS: So effectively, in some ways, it ends up being the same thing where - as a dividend, you have the stock and then you have some cash. But with the buyback, you have the stock that just became more valuable. There is a tax difference. As the shareholder receiving a dividend, that's just cash. And any time you just get cash like that, that gets taxed.
GARCIA: So that same year you get the dividend, you've got to pay taxes on it.
CHILDS: Money coming into your pocket - the government wants some. In the case of share buybacks, though, the stock just went up, and you can kind of just hang on and not have to sell it. And you only have to pay taxes on that now-higher stock when you actually sell it.
GARCIA: OK, so you can basically hold onto it and avoid paying taxes for a while.
CHILDS: Yes, although you are taking the chance that the stock might plummet at some point, so...
GARCIA: Yeah. If it goes down...
CHILDS: ...It's a little bit like - it's less in your pocket.
GARCIA: Yeah, it's more risky. OK.
Mary, thanks so much.
CHILDS: Thanks for having me.
GARCIA: Always a pleasure - I owe you a peppermint patty.
CHILDS: Yeah, you do.
GARCIA: So I'm going to go buy you that right now.
CHILDS: Thank you.
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GARCIA: This episode of THE INDICATOR was produced by Rachael Cohn, fact-checked by Emily Lang and edited by Paddy Hirsch. THE INDICATOR is a production of NPR.
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CHILDS: I have a request. You know that part when I'm fiddling with my bag trying to find my peppermint patty and I'm like, we have to split it?
GARCIA: Did you say - I'm not sure you said that. Rachel, producer - Rachel, can you be the tiebreaker here?
COHN: So actually, I went back through the audio because I wasn't sure myself, but it is there. Mary says it.
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