Counterpoint Global Insights

Wealth Transfers
Redistribution of Value via Capital Allocation

CONSILIENT OBSERVER | May 10, 2022

Introduction AUTHORS

The core of capitalism is the private ownership of the means of Michael J. Mauboussin
production in the pursuit of economic profit. A company generates [email protected]
a positive economic profit when it earns a return on investment in Dan Callahan, CFA
excess of the opportunity cost of capital. [email protected]

Competition is a feature of capitalism. A company earning a

handsome economic profit will attract competitors that seek to
wrest that profit away either by selling similar goods or services at
a lower cost or by providing attractive substitute offerings.
Productive investment is the engine of capitalism. Companies
spend on tangible or intangible assets with the expectation that
future cash flows, discounted to the present, will be worth more
than the outlay. Successful investment creates wealth because
one dollar of investment is worth more than one dollar in value.
Creditors and equity holders provide the capital to invest. Creditors
have a senior claim on cash flows and hence have lower risk and
expected return than equity holders. Equity holders have a residual
claim on cash flows, so they have higher risk and potential reward.
Once a company is up and running, the primary source of
investment capital tends to be cash that is generated internally.
Since 1980, internal financing has supplied more than 90 percent
of the capital for investment in the U.S.1 This can come from
retained earnings or other stakeholders, including suppliers.2
Capital allocation is arguably a management team’s most
important task. The goal of capital allocation is to put resources to
their best and highest use so as to create long-term value per share
for ongoing shareholders. You can think of capital allocation in two
parts. One is investing in the business, which includes familiar
forms such as capital expenditures, intangible assets, and mergers
and acquisitions.
The other is transacting with securities that have prices that are
based on corporate value, including buying and selling the debt and
equity of a company. This introduces the potential for a wealth
transfer, where one stakeholder benefits at the expense of another.
Wealth Transfers

A wealth transfer occurs when a company buys or sells a mispriced security.3 We focus on equity. The intuition
is straightforward and amounts to little more than “buy low and sell high.” The essential issue is whether
executives can discern between price and value. In theory, they should have information about the prospects
for their companies that investors lack. This can provide an opportunity to initiate a wealth transfer.

The empirical research on the topic comes to a few conclusions. First, companies can indeed time the sale and
purchase of equity so as to benefit ongoing shareholders. 4 Second, wealth transfers tend to be larger for sales
of overpriced equity than they are for purchases of undervalued equity.5 Third, institutional investors are
generally more discerning than individual investors when transacting with a company.6

Richard Sloan and Haifeng You, professors of accounting, find that companies buying and selling equity transfer
one to two percent of the pre-deal market value from the transacting shareholders to the ongoing shareholders,
measured five years after the event.7

An important implication of these transfers is that a stock’s dollar-weighted average return can be less than its
time-weighted return. Total shareholder returns are generally reported using time-weighted returns. This concept
is related to the observation that mutual fund investors generally earn lower returns than the funds in which they
invest because of poor timing. For example, the dollar-weighted returns were 117 basis points lower than time-
weighted returns for U.S. equity mutual funds for the 10 years ended December 31, 2020. 8

Ilia Dichev, a professor of accounting, provides an example to make the point clear (we modify his numbers
modestly).9 A company starts with 1,000 shares of a stock that trades at $100 a share. The stock then doubles
to $200 and the company sells 1,000 shares. Finally, the stock returns to $100.

It is obvious that the initial shareholders are flat on their investment and the new shareholders are down 50
percent. In fact, in this scenario the dollar-weighted return is -26.8 percent, measured using internal rate of return
(IRR). But the time-weighted return is zero because the stock ended where it began.

This analysis is based on price change, which is what investors ultimately care about. Wealth transfers rely on
a stock being mispriced, which presumes that price differs from intrinsic value. When we introduce value, we
can observe that selling overvalued stock and buying back undervalued stock add to firm value per share.
Symmetrically, buying back overvalued stock and selling undervalued stock subtract from firm value per share
(see exhibit 1).

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 2

Exhibit 1: Wealth Transfers Via Equity Transactions

Stock Price
Undervalued Overvalued

• Buyers gain • Buyers lose

Sells
• Ongoing holders lose • Ongoing holders gain

Company

• Sellers lose • Sellers gain

Buys
• Ongoing holders gain • Ongoing holders lose

Source: Counterpoint Global.

Let’s return to our example. Say the intrinsic value of the firm at the outset is $100,000 and that the price
accurately reflects that value ($100 per share x 1,000 shares outstanding = $100,000). The stock rises to $200,
and the firm sells 1,000 shares. The new value of the firm is $300,000 ($300,000 = $100,000 + $200,000 in
proceeds) and the value per share rises from $100 to $150 per share ($150 = $300,000 ÷ 2,000 shares
outstanding). The wealth transfer is from the buying shareholders to ongoing holders, which becomes clear if
the stock price declines to $150 and matches its new value per share. Buying shareholders lose $50 per share
while the ongoing holders gain $50. Note that the price regresses to a higher value.

We can start with the same intrinsic value and price and see what happens if the company buys back
undervalued stock. Now assume the stock drops from $100 to $50 and the company repurchases 500 shares.
The value of the firm decreases to $75,000 ($75,000 = $100,000 - $25,000 repurchase cost) but the value per
share increases to $150 per share ($150 = $75,000 ÷ 500 shares outstanding). The wealth transfer is from the
selling shareholders to the ongoing holders if price and the new value align. Selling shareholders lose $50 per
share and ongoing holders gain $50.

A company that sells overvalued stock increases the value per share for the ongoing holders. But it should be
noted that those holders would be better off selling alongside the firm. A company that buys undervalued stock
also augments value per share. But in this case, ongoing shareholders improve their situation by doing nothing.

This analysis is relevant for stocks that gain attention through social media and appeal primarily to retail
investors. These are colloquially called “meme stocks” because the individuals who buy them commonly react
to ideas developed and spread on the Internet.10 Consider that the net daily purchases of U.S equities and
exchange-traded funds by individuals at the height of popularity for meme stocks was roughly 10 times the level
of purchases in 2019 before major online brokerage firms moved to zero commissions.11

The large price changes of these stocks suggest mispricing. These stock price spikes present an opportunity for
a wealth transfer via corporate action.

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 3

We designated value in our example so as to illustrate the point. But in reality, determining intrinsic value is
much more difficult. To simplify our analysis, we use the average target price of the sell-side analysts who cover
a stock as a proxy for intrinsic value. As is generally known, target prices are not very accurate and tend to be
optimistic. This means that realized prices tend to fall short of the target.12 The math of wealth transfers still
works, but the magnitude of the effect is muted if the target price is higher than the intrinsic value.

The recent case of GameStop, a retailer of video games and consumer electronics, is an example of equity
issuance executed at a price that substantially exceeded value as implied by the target price of analysts. On
April 9, 2021, GameStop had 65.3 million shares outstanding and the stock closed at $158.36. Between June 9
and June 22, GameStop sold 5 million shares at an average price of $225.20 per share. During the time of the
sale, the average target price was $65.48.

The intrinsic value increased from $65.48 to $76.84 per share, a gain of more than 17 percent, as a result of the
issuance.13 On August 11, 2021, the stock closed at $158.78. Measuring stock price returns from roughly two
months before the issuance to two months after reveals an IRR of -1.4 percent but a time-weighted gain of 0.3
percent.

Another noteworthy aspect of the transaction is that the company added more than $1.1 billion to its balance
sheet. This introduces a capital allocation opportunity and risk. The capital creates additional wealth if it is
deployed into the operations and earns a return in excess of the cost of capital. But an investment below the
cost of capital is a drag on the value of the operations.14

AMC Entertainment Holdings, a movie theater chain, is another company with equity that qualified as a meme
stock. The company sold stock in a similar fashion. Indeed, its actions had an even larger impact on intrinsic
value than was the case for GameStop. AMC chose to deploy some of its cash into a gold mine company,
Hycroft Mining, hence diversifying away from its core operations.15

Conclusion

Companies can affect wealth in a couple of ways. First, they can make investments in their operations that earn
in excess of the cost of capital. This activity benefits capital providers. But sustaining returns above the cost of
capital is challenging because of competition and the inevitable maturation of various markets for goods or
services.

Companies can also transfer wealth by buying or selling mispriced stock. The evidence shows that in the
aggregate companies do sell high and buy low, which means that transacting shareholders fare worse than
ongoing holders.

Astute investors focus on a management’s ability to allocate capital and tend to focus on investments in the
business. This is appropriate. But investors should also be aware of the impact of management actions with
regard to their own stock. The essential guide is the gap between price and value.

Finally, many investors count on mispriced stocks regressing toward their value per share over time as a means
to generate excess returns. Wealth transfers show that actions by management can change the value per share
without any change in the underlying fundamentals of the operations.

Please see Important Disclosures on pages 7-9

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 4

Endnotes
1 Board of Governors of the Federal Reserve System, Division of Research and Statistics, Flow of Funds
Accounts Table F.103. See https://www.federalreserve.gov/releases/z1/20220310/z1.pdf, page 18.
2 This can be seen through analysis of the cash conversion cycle, a measure of how long it takes to convert

investments in inventory into cash. Companies with a negative cash conversion cycle receive cash for the goods
or services they produce before they have to pay their suppliers. This timing difference is a source of cash as
long as the business grows.
3 Wealth transfers can happen by other means as well. One of the best examples is captured in the principal-

agent problem. In this case, the principal is the shareholder and the agent is the manager of the business. The
problem arises when the agent enriches his or herself, for instance through unnecessary perquisites, that
transfer wealth from the principal to the agent. Other potential but more ambiguous cases include leveraged
recapitalizations, where companies borrow money to repurchase stock, and spinoffs.
4 Amy Dittmar and Laura Casares Field, “Can Managers Time the Market? Evidence Using Repurchase Price

Data,” Journal of Financial Economics, Vol. 115, No. 2, February 2015, 261-282; Richard G. Sloan and Haifeng
You, “Wealth Transfers via Equity Transfers,” Journal of Financial Economics, Vol. 118, No. 1, October 2015,
93-112; Ilona Babenko, Yuri Tserlukevich, and Pengcheng Wan, “Is Market Timing Good for Shareholders?”
Management Science, Vol. 66, No. 8, August 2020, 3542-3560; and Dinis Daniel Santos and Paulo Gama,
“Timing the Market with Own Stock: An Extensive Analysis with Buying and Selling Evidence,” International
Journal of Managerial Finance, Vol. 16, No. 2, 2020, 141-164.
5 A related finding is that “IPO firms underperform the market for the three and five years after the IPO.” From

Michelle Lowry, Roni Michaely, and Ekaterina Volkova, “Initial Public Offerings: A Synthesis of the Literature and
Directions for Future Research,” Foundations and Trends in Finance, Vol. 11, No. 3-4, 2017, 154-320.
6 R. Jared DeLisle, Justin D. Morscheck, and John R. Nofsinger, “Share Repurchases and Wealth Transfer

Among Shareholders,” Quarterly Review of Economics and Finance, Vol. 76, May 2020, 368-378; Randolph B.
Cohen, Paul A. Gompers, and Tuomo Vuolteenaho, “Who Underreacts to Cash-Flow News? Evidence from
Trading between Individuals and Institutions,” Journal of Financial Economics, Vol. 66, Nos. 2-3, November-
December 2002, 409-462; and John R. Nofsinger and Richard W. Sias, “Herding and Feedback Trading by
Institutional and Individual Investors,” Journal of Finance , Vol. 54, No. 6, December 1999, 2263-2295.
7 Sloan and You, “Wealth Transfers via Equity Transfers” and Ulrike Malmendier, “Behavioral Corporate

Finance,” in B. Douglas Bernheim, Stefano Della Vigna, and David Laibson, eds., Handbook of Behavioral
Economics—Foundations and Applications 1 (Amsterdam: North Holland, 2018), 277-380.
8 Amy C. Arnott, “Mind the Gap 2021: A Report on Investor Returns in the United States,” Morningstar, August

31, 2021.
9 Ilia D. Dichev, “What Are Stock Investors’ Actual Historical Returns? Evidence from Dollar-Weighted Returns,”

American Economic Review, Vol. 97, No. 1, March 2007, 386-401.

10 The Merriam-Webster dictionary defines a meme as “an idea, behavior, style, or usage that spreads from

person to person within a culture.”

11 Spencer Jakab, The Revolution That Wasn't: GameStop, Reddit, and the Fleecing of Small Investors (New

York: Portfolio/Penguin, 2022), 139.

12 Stefano Bonini, Laura Zanetti, Roberto Bianchini, and Antonio Salvi, “Target Price Accuracy in Equity

Research,” Journal of Business Finance & Accounting, Vol. 37, Nos. 9 and 10, November/December 2010,
1177-1217; Mark T. Bradshaw, Lawrence D. Brown, and Kelly Huang, “Do Sell-side Analysts Exhibit Differential
Target Price Forecasting Ability?” Review of Accounting Studies, Vol. 18, No. 4, December 2013, 930-955; and
Mark T. Bradshaw, “The Use of Target Prices to Justify Sell-Side Analysts’ Stock Recommendations,”
Accounting Horizons, Vol. 16, No. 1, March 2002, 27-41. Target prices can be improved through the use of
distributions. See Guy Weyns, Juan-Luis Perez, Barry Hurewitz, and Vlad Jenkins, “Morgan Stanley’s Risk-
Reward Views: Unlocking the Full Potential of Fundamental Analysis,” Journal of Applied Corporate Finance,
Vol. 23, No. 2, Spring 2011, 59-68; Patricia M. Dechow and Haifeng You, “Understanding the Determinants of
Analyst Target Price Implied Returns,” Accounting Review, Vol. 95, No. 6, November 2020, 125-149.
13 Here’s the math. The company’s implied intrinsic value before the transaction was $4,276 million, or 65.3

million shares times $65.48 per share. The company sold stock worth $1,126 million, the product of 5 million

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 5

shares and a price of $225.20. The new value of the firm is $5,402 million, or $4,276 plus $1,126 million, which
divided by the new shares outstanding of 70.3 million (65.3 + 5.0 million) equals $76.84 per share.
14 “Investment” is one of the factors (others include size, value, momentum, and quality) in a number of prominent

factor models that seek to explain equity returns beyond the output of the capital asset pricing model. The
common way to measure investment is the growth in assets, and the general conclusion is that rapid asset
growth is associated with poor subsequent total shareholder returns. More recent work parses asset growth into
investment and non-investment components. Rapid asset growth as the result of investment growth does not
predict poor returns. By contrast, rapid asset growth as the result of equity issuance but without investment
does. See Michael Cooper, Huseyin Gulen, and Mihai Ion, “The Use of Asset Growth in Empirical Asset Pricing
Models,” Working Paper, August 2020.
15 Alexander Gladstone and Caitlin McCabe, “A New Meme-Stock Frenzy Led AMC to Gold Mine Stake,” Wall

Street Journal, March 15, 2022.

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 6

IMPORTANT INFORMATION

The views and opinions and/or analysis expressed are those of the author as of the date of preparation of this
material and are subject to change at any time due to market or economic conditions and may not necessarily
come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that
subsequently becomes available or circumstances existing, or changes occurring, after the date of publication.
The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment
Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all
the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass.
Information regarding expected market returns and market outlooks is based on the research, analysis and
opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to
pass and are not intended to predict the future performance of any specific strategy or product the Firm offers.
Future results may differ significantly depending on factors such as changes in securities or financial markets or
general economic conditions.

Past performance is no guarantee of future results. This material has been prepared on the basis of publicly
available information, internally developed data and other third-party sources believed to be reliable. However,
no assurances are provided regarding the reliability of such information and the Firm has not sought to
independently verify information taken from public and third-party sources. The views expressed in the books
and articles referenced in this whitepaper are not necessarily endorsed by the Firm.

This material is a general communications which is not impartial and has been prepared solely for information
and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular
security or to adopt any specific investment strategy. The material contained herein has not been based on a
consideration of any individual client circumstances and is not investment advice, nor should it be construed in
any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal
and financial advice, including advice as to tax consequences, before making any investment decision.

Charts and graphs provided herein are for illustrative purposes only. Any securities referenced herein are solely
for illustrative purposes only and should not be construed as a recommendation for investment.

This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a
research material or a recommendation.

The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and
distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are
required to satisfy themselves that the information in this material is appropriate for any person to whom they
provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and
accepts no liability for, the use or misuse of this material by any such financial intermediary.

The whole or any part of this work may not be directly or indirectly reproduced, copied, modified, used to create
a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any
of its contents disclosed to third parties without MSIM’s express written consent. This work may not be linked to
unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary
and is protected under copyright and other applicable law.

Eaton Vance is part of Morgan Stanley Investment Management. Morgan Stanley Investment Management is
the asset management division of Morgan Stanley.

This material may be translated into other languages. Where such a translation is made this English version
remains definitive. If there are any discrepancies between the English version and any version of this material
in another language, the English version shall prevail.

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 7

DISTRIBUTION

This communication is only intended for and will only be distributed to persons resident in jurisdictions
where such distribution or availability would not be contrary to local laws or regulations.

MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have
arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated
as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management
(International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management,
Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.

This material has been issued by any one or more of the following entities:

EMEA
This material is for Professional Clients/Accredited Investors only.
In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited
(“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company
limited by shares with company registration number 616661 and has its registered address at The
Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland.

Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is
authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121.
Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch)
Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ("FINMA"). Registered Office:
Beethovenstrasse 33, 8002 Zurich, Switzerland.

Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International)
Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the
United Kingdom by the Financial Conduct Authority.

Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121
Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1
1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain:
MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL Frankfurt Branch,
Große Gallusstraße 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b
KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609
Copenhagen V, Denmark.

MIDDLE EAST
Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct
Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14
709 7158).

This document is distributed in the Dubai International Financial Centre by Morgan Stanley Investment
Management Limited (Representative Office), an entity regulated by the Dubai Financial Services Authority
(“DFSA”). It is intended for use by professional clients and market counterparties only. This document is not
intended for distribution to retail clients, and retail clients should not act upon the information contained in this
document.

U.S.
NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY
FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

ASIA PACIFIC
Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall
only be made available to “professional investors” as defined under the Securities and Futures Ordinance of
© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 8
Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory
authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an
exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed
at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan
Stanley Investment Management Company and should not be considered to be the subject of an invitation for
subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore
other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of
Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of
the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii)
otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.
This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This material is
provided by Morgan Stanley Investment Management (Australia) Pty Ltd ABN 22122040037, AFSL No.
314182 and its affiliates and does not constitute an offer of interests. Morgan Stanley Investment Management
(Australia) Pty Limited arranges for MSIM affiliates to provide financial services to Australian wholesale clients.
Interests will only be offered in circumstances under which no disclosure is required under the Corporations
Act 2001 (Cth) (the “Corporations Act”). Any offer of interests will not purport to be an offer of interests in
circumstances under which disclosure is required under the Corporations Act and will only be made to persons
who qualify as a “wholesale client” (as defined in the Corporations Act). This material will not be lodged with
the Australian Securities and Investments Commission.

Japan
This material may not be circulated or distributed, whether directly or indirectly, to persons in Japan other than
to (i) a professional investor as defined in Article 2 of the Financial Instruments and Exchange Act (“FIEA”) or
(ii) otherwise pursuant to, and in accordance with the conditions of, any other allocable provision of the FIEA.
This material is disseminated in Japan by Morgan Stanley Investment Management (Japan) Co., Ltd.,
Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the
Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment
Advisers Association and the Type II Financial Instruments Firms Association.

© 2023 Morgan Stanley. All rights reserved. 5711670 Exp. 5/31/2024 9