In response, the firm issued $24.3 billion of equity, the largest equity offering in U.S. history. 170 million shares were issued to add to the existing 618 million shares outstanding. That strengthened the firm’ s balance sheet, a necessity, but what a shame! Issuing equity at such low prices dilutes the existing shareholders’ equity. The shareholders might avoid bankruptcy but now have to share the possible recovery with other shareholders.  They suffer a double whammy, the large drop in the share price with the operational issues and the effect of issuing stock at a much-reduced share price. Echo of the Deutsche Bank episode mentioned in chapter 5.

The Modigliani and Miller theorem assumes debt and equity can be traded costlessly in so-called perfect capital markets, so explanations for capital structure are often based on relative costs associated with debt and equity. For example, interest on debt is tax deductible whereas dividends are not, favoring debt. Or debt incurs bankruptcy costs, favoring equities. Or debt financing is not available for start-ups, so they must be all equity financed.

However, there is a value investing view of capital structure. The value investor buys equities when they are cheap and sells them when they are deemed overpriced. Similarly, he or she buys bonds when they are underpriced and sells them when they are overpriced. Following the principle that trading in mispriced securities adds value for shareholders, the CFO or Treasurer of a firm can be a value investor when financing the firm: If debt is overpriced, issue debt rather than equity; if the firm’s shares are overpriced, issue equity rather than debt. That determines the capital structure. The capital structure is also affected if the CFO repurchases underpriced shares or underpriced debt. The CFO, of course, has privy to information about the pricing of the firm’s debt and equity (although must be aware of laws on trading on private information).

A share repurchase will not counterbalance the earnings impact. It will reduce earnings because those from its asset management would be lost, as would those earned by reinvesting the €3.8 billion. However, with fewer shares outstanding, EPS likely increases. But, if the repurchase is at fair market value, there is no value enhancement for the firm’s shareholders.

Of course, if Axa had no use for the €3.8 billion, it is correct to pass it out to shareholders as they might have a better use for it than Axa.

That is, the stock repurchase is a signal of value. This is similar to dividend signaling: Paying dividends typically does not add value (as chapter 3 explains) but can convey information that management believe that earnings in the future will be sufficient to cover the increased dividend^2M and earnings do add value.

The S&P Buyback Index^2Mequally weighted index of 100 firms in the S&P 500 with the highest proportion of cash spent on buybacks relative market capitalization^2M has outperformed the broader S&P 500 equally weighted index 14 out of 20 years up to 2024. In 2024, considerably more large UK companies repurchased shares than US companies. A signal of undervaluation of the FTSE 100 relative to the S&P 500? The UK index traded at a forward P/E of 12.2 compared with 23.6 for the S&P 500. By March 2025, the FTSE was up 7.14% for the calendar year.

A firm with no value-added investment opportunities can make a repurchase at fair value, for shareholders may have value adding investment opportunities on personal account that the firm does not have. But repurchases can lose value if made at prices higher than fair value. Activist shareholders who have investment opportunities sometimes advocate for share repurchases but can hurt other investors in their desire for cash if repurchases are at a high price.

The firm announced it was issuing 45 million shares while also saying the swings in its share price “do not appear to be based on the underlying fundamentals of our business.” The firm was taking advantage of overpriced shares to issue stock. Suckers will subscribe to the offering. By March 2025, the stock price was down to $24.60.

• Viewing ROE affected by leverage as an indication of value added
• Rewarding management based on ROE
• Buying low P/E affected by leverage
• Seeing an increase in P/B as added value if it is due to leverage
• Buying earnings growth resulting from leverage
• Viewing an increase in EPS from a stock repurchase as added value

Here is another example of muddled thinking:

The AAA (American Automobile Association) estimated that the cost of owning a car increased 15.4% in 2023 but most of that was due to an increase in the interest rate of auto loans. That is not the cost of owning a car, but the cost of borrowing. New car prices rose only 0.7% in 2023, and the price of gas (petrol) fell significantly (though auto insurance premiums rose 20.6%). (Source: Wall Street Journal February 14, 2024).

        Levered P/B = Unlevered P/B + [Book Leverage x (Unlevered P/B – 1)]

The equation can be expressed in terms of B/P rather than P/B:

In the P/B equation, leverage is book leverage =In the B/P version, leverage is market leverage =