Do company layoffs always mean good news for investors? While it might seem like cutting costs would automatically boost a company's value, the reality is more complex. Today we’ll get into the reasons behind layoffs, how they affect stock prices, and what it means for you as an investor.
Mass Layoffs in the Tech Industry
In 2023, 263,180 workers at U.S.-based tech companies were laid off, and the trend has continued into 2024. As of now, Layoffs.fyi has tracked 90,916 employees losing their jobs this year. That’s more than 780 firings each day!
Here's a look at the biggest tech layoffs in 2023, along with their stock values shortly after:
Amazon laid off 16,080 roles, which led to their stock value increase by 9% within a month after the layoffs were announced. Amazon’s decision was driven by the need to reduce expenses and increase profitability, focusing on optimising their operational efficiency. The layoffs affected various divisions, including the Alexa voice assistant unit, devices group, and retail operations, where overstaffing and shifting market demands necessitated a reduction in workforce.
Alphabet laid off 12,000 roles, leading to 15% stock value increase following their announcement of job cuts in the month. The company had conducted a rigorous review and elimination across product areas, functions, levels, and regions to channel their efforts into AI technology.
Microsoft laid off 11,158 roles, leading to a 6% increase in stock value within the month of the job cut announcement. The company's CEO mentioned plans to invest in generative artificial intelligence, particularly in OpenAI, the startup behind the chatbot sensation ChatGPT, which Microsoft plans to market through its cloud service.
Meta laid off 10,000 roles, leading to stock value increase of 50%. The layoffs aimed to restructure the company by canceling lower-priority projects and reducing hiring rates, while also 'removing layers of middle management to make decisions faster.' However, the tech giant continued to invest billions in developing the virtual reality and augmented reality technologies required for the metaverse.
So, do layoffs actually pay off?
At a glance, the idea of slashing a company’s headcount might translate to a surge in stock price, but there’s more to the story. Cutting jobs to increase profitability may not necessarily improve stock prices.
In general, stock prices are based on how people perceive the company. If they believe the layoffs would help the company, it could result in more people placing their bids. Conversely, mass layoffs can also give investors a hint that a company is struggling. If they see the layoffs as a bad sign, they would sell their shares out of fear or a lack of confidence in the company.
For example, Wayfair’s stock price quickly fell after their initial rise after layoffs. The stock gave up almost all of its post-layoff gains after reporting a wider fourth-quarter loss. This highlights how layoffs alone might not convince investors of a turnaround for struggling companies.
To build on this, a study showed that companies with little to no layoffs performed significantly better than those with mass layoffs:
Companies with minimal layoffs (3% or less) saw a 9% share price increase (similar to no layoffs).
Companies with moderate layoffs (3-10%) experienced flat share price movement.
Companies with significant layoffs (over 10%) saw a 38% drop in share prices.
Reasons for layoffs
1. Financial strain and economic downturns
When economic conditions deteriorate or a company faces financial hardship, reducing labor costs through layoffs becomes a strategy to improve profitability and weather the storm.
2. Restructuring and streamlining
Companies may implement layoffs as part of a broader restructuring effort. This could involve eliminating redundant positions, realigning resources to focus on core business areas, or streamlining operations to adapt to a changing market landscape or evolving strategic priorities.
3. Mergers, acquisitions and reorganizations
Mergers and acquisitions often lead to workforce consolidation to eliminate duplicate roles. Layoffs become a tool to achieve synergies and cost savings during the integration process.
4. External market forces
Shifts in consumer preferences, technological advancements, regulatory changes, or industry disruptions can all prompt companies to adapt by reducing their workforce. Layoffs help them adjust to the new market dynamics and maintain competitiveness.
Why are employees the first to get cut?
Employees are often the first to be cut because they represent a significant portion (about (about 65% - 70%) of a company's total costs. In short, keeping employees is expensive, which unfortunately makes them a prime target for cost-cutting measures. Unlike expenses in areas like sales tools or R&D, which can be adjusted or scaled back, employee salaries and benefits are relatively fixed.Imagine a company has to pay an extra 20% on each employee's salary. So, if an employee currently makes RM4,000 per month, the additional cost would be 20% of RM4,000, which is RM800. This means the total cost per employee would increase to RM4,800.
Because of this significant increase, the company is looking to cut back on their overall expenses by 30%. This means they need to find ways to save money across the entire company to offset the extra cost per employee.
To achieve this, the employer has two options: either lay off 30% of the employees or reduce each employee's salary by 36%. While both methods aim to reduce costs, most companies are likely to choose the first option, as cutting salaries can negatively affect employee morale and productivity.Layoffs are also quicker and easier to implement than restructuring departments or renegotiating contracts. Though this may seem harsh, it is often seen as the most efficient way to reduce costs. In summary, reducing headcount offers a more immediate and direct reduction in overall costs for companies.
What to consider as an investor
If you’re an investor wondering how to manage your portfolio amidst the trend of layoffs, consider these key factors:
1. Impact on Profitability
Reducing headcount can increase operating profit and free cash flow, potentially boosting stock prices. However, the immediate financial benefits may vary based on the company's overall health and market conditions.
2. Timing and Context
The timing of layoffs can affect how quickly the benefits are seen in financial reports. Consider whether the layoffs are part of a strategic restructuring or a response to external pressures.
3. Employee Morale and Productivity
Layoffs can negatively impact remaining employees' morale and productivity, which might offset some financial gains. Companies with poor morale may struggle to maintain productivity and innovation.
4. Underlying Business Issues
Layoffs might not address fundamental problems within the company. Look beyond immediate cost savings to understand if the layoffs are masking deeper issues.
The Bottom Line
To summarise, layoffs aren't a guaranteed path to stock price growth. Don’t just assume a stock is going to go up just because it cut people. The recommended approach is to do thorough research and monitor long-term trends to properly assess the impact of layoffs on stock prices. This includes looking at the company's financial health, strategic goals, and market trends.
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