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Help me understand share buy backs
Old 05-06-2019, 08:40 PM   #1
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Help me understand share buy backs

I understand that much of the increase in earnings per share in recent years has been due to share buy backs by companies. I get that...if there are fewer shares outstanding, then the earnings attributable to each share is higher and each share is worth more.

What I don't really get is why the market cap of the company would increase and I'd appreciate if someone could help me understand.

For instance, if Company X previously had 1,000 shares outstanding and earned $10/share, but bought back half the outstanding shares then they'd now have 500 shares outstanding earning $20/share. Each outstanding share is worth more, justifiably. But with only half as many shares outstanding, shouldn't the market cap (i.e. value of the entire entity) remain the same?

Please help me understand what I'm missing. Thanks.
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Old 05-06-2019, 08:56 PM   #2
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You aren't missing anything. (# of shares) * (prices / share) = market cap.
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Old 05-06-2019, 09:36 PM   #3
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Why do you think the market cap increases? Other than normal stock fluctuations after the buyback.
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Old 05-06-2019, 09:54 PM   #4
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Re you not intermixing earnings with market price?

Just because the earnings per share increase 100% doesn't mean the price per share increases 100%.
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Old 05-06-2019, 10:26 PM   #5
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It’s kinda like a dividend without a taxable event.
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Old 05-06-2019, 10:50 PM   #6
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No, the market capitalization does not increase after a buyback unless the % increase in the stock price is greater than the % decrease in outstanding shares.

The market capitalization could drop after a buyback.
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Old 05-07-2019, 08:47 AM   #7
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Quote:
Originally Posted by RenoJay View Post
I understand that much of the increase in earnings per share in recent years has been due to share buy backs by companies. I get that...if there are fewer shares outstanding, then the earnings attributable to each share is higher and each share is worth more.

What I don't really get is why the market cap of the company would increase and I'd appreciate if someone could help me understand.

For instance, if Company X previously had 1,000 shares outstanding and earned $10/share, but bought back half the outstanding shares then they'd now have 500 shares outstanding earning $20/share. Each outstanding share is worth more, justifiably. But with only half as many shares outstanding, shouldn't the market cap (i.e. value of the entire entity) remain the same?

Please help me understand what I'm missing. Thanks.
Typically, stock buybacks happen in a period when a company is flush with cash and has reported better than average results, the amount of shares the company purchases and the effect on it's price has nothing to do with a mathematical balance equation and everything to do with supply and demand, stock buybacks reduce supply and increase demand. When the stock sinks and times are bad, even if the company is sure they will get out of the situation, they no longer have funds to buy the stock back and indeed will often offer shares for cash at the bottom. See 2006/2007/2008/2009 for various companies and their activities on stock buybacks and share issuance.

Buying stock back can hold an individual stock up for a long time with artificial demand, for a good example see GE and mark their purchases against their stock price, they bought billions right up to the point where they could no longer afford to pay dividends.

Indeed the main beneficiary of stock buybacks is management who are obtaining shares every year for free no matter whether the price is at a low or a high and the artificial demand created by stock buybacks creates income out of thin air for executives without doing anything to actually improve the company.
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Old 05-07-2019, 09:00 AM   #8
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I thought this was a particularly insightful recent post on this topic:
https://www.ofwealth.com/dont-ignore...hen-investing/
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Old 05-07-2019, 09:01 AM   #9
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Thanks everyone. A lot of what I've been reading about in the press is that the market is up because of buy backs. The replies thus far have convinced me that buy backs, of themselves, should not be pushing up the indices.

My personal belief is that there's euphoria / bubble mentality going on in the stock market currently, but I wanted to see if I misunderstood a basic mathematical concept.
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Old 05-07-2019, 09:13 AM   #10
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Itís not simple euphoria. Read the article I posted, which shows that US companies have traded lower dividend payments for aggressive stock buybacks. The two combined affect earnings per share positively.
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Old 05-07-2019, 09:15 AM   #11
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But when a company buys back shares cash is LEAVING the company so shouldn't that decrease the value of the company? If a company has $1 million dollars and 1 million shares outstanding presumably each share is worth $1 and the market cap is $1 million. If the company buys back 500,000 shares (half of its shares) for $1 each, its remaining shares are still worth $1 per share but its market cap should only be $500,000 (half). In this example, the company is buying back shares for what they are actually worth. But if a company buys back shares for more than they are worth, that would DECREASE the value of the remaining outstanding shares and decrease the market cap even further. Share buybacks only make sense if the shares are being repurchased for less than they are worth.
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Old 05-07-2019, 09:31 AM   #12
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The article linked by Markola says:

"Whether a company distributes cash as a dividend or a stock buyback, remaining shareholders get the same benefit. A dividend causes a price drop in exchange for cash. A buyback doesn’t cause a price drop, but there is no cash income. Net-net, they’re the same."

This seems ridiculous to me. A buyback is certainly not the "same benefit" as a dividend. Buybacks DECREASE the value of the remaining outstanding shares (with no corresponding cash payment to remining stockholders) if the shares are bought back for more than they are worth (which is probably the case most of the time because the added demand from buybacks inflate stock prices above true value). The argument that buybacks are a scam invented by managements to enrich themselves seems to have a lot of merit to me.
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Old 05-07-2019, 09:44 AM   #13
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One justification for buybacks I hear is that buybacks increase EPS and since buyers often base what they are willing to pay for stock on a multiple of EPS, then buybacks should increase stock price. If this is true, then dividends are "free money." If stock prices are really determined primarily by EPS, then dividends (which have NO IMPACT on EPS) should not decrease market price at all.
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Old 05-07-2019, 11:34 AM   #14
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Except that some (a lot of) companies are using debt to finance the buybacks.

I think buy backs are a sad statement that the company can't find anything better to invest in for long term growth (capital equipment to grow the business, mergers, etc). It might make sense for a company with a boat load of cash. But borrowing to do it, even at low rates, doesn't seem like a good long term decision.
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Old 05-07-2019, 12:09 PM   #15
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Quote:
Originally Posted by Running_Man View Post
Typically, stock buybacks happen in a period when a company is flush with cash and has reported better than average results, the amount of shares the company purchases and the effect on it's price has nothing to do with a mathematical balance equation and everything to do with supply and demand, stock buybacks reduce supply and increase demand. When the stock sinks and times are bad, even if the company is sure they will get out of the situation, they no longer have funds to buy the stock back and indeed will often offer shares for cash at the bottom. See 2006/2007/2008/2009 for various companies and their activities on stock buybacks and share issuance.

Buying stock back can hold an individual stock up for a long time with artificial demand, for a good example see GE and mark their purchases against their stock price, they bought billions right up to the point where they could no longer afford to pay dividends.

Indeed the main beneficiary of stock buybacks is management who are obtaining shares every year for free no matter whether the price is at a low or a high and the artificial demand created by stock buybacks creates income out of thin air for executives without doing anything to actually improve the company.
Which companies offer stock when prices are low? Very rare I believe. Established companies don't generally make additional stock offerings to the public unless they are spinning off part of their company into a separate entity. And in that case it's the new company stock that is being offered.

I agree in general that buybacks are often financial engineering that doesn't benefit the long-term health of the company, and can often hurt the future, but usually enriches the officers in the short term.
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Old 05-07-2019, 01:26 PM   #16
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You may benefit from reading or watching an accounting tutorial on "Capital Accounts" on a Balance Sheet.

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Old 05-07-2019, 01:50 PM   #17
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Which companies offer stock when prices are low? Very rare I believe. Established companies don't generally make additional stock offerings to the public unless they are spinning off part of their company into a separate entity. And in that case it's the new company stock that is being offered.

I agree in general that buybacks are often financial engineering that doesn't benefit the long-term health of the company, and can often hurt the future, but usually enriches the officers in the short term.
1) AIG -

March 2, 2007

BOSTON (MarketWatch) — Shares of American International Group Inc. got an early lift Friday, gaining as the company reported higher fourth-quarter net income and said its board has approved a major stock-repurchase plan.

On September 16, 2008, in exchange of the money it pumped into the company, the U.S. government received nearly 80% of the firm's equity. For decades, AIG was the world's biggest insurer, a company known around the world for providing protection for individuals, companies, and others. But in September, the company would have gone under if it were not for government assistance.

2 - Lehman Brothers - NEW YORK, Jan 29 2008 (Reuters) – Lehman Brothers Holdings Inc, the Wall Street investment bank, on Tuesday raised its common stock dividend 13 percent and said its board of directors authorized the buyback of up to 100 million shares.

New York-based Lehman said the buyback program covers nearly 19 percent of its 530.6 million shares outstanding at year end, and supersedes a prior authorization.

The shares covered by the new program are worth about $6.25 billion, based on Lehman’s Tuesday closing price. Lehman shares rose $1.90, or 3.1 percent, on Tuesday to close at $62.53 on the New York Stock Exchange.
3-
Bank of America

In an almost comical sequence of events in the years before the crisis, Bank of America spent $40 billion on buybacks only to then have to raise roughly the same amount of capital after the crisis took hold. There are few companies that have destroyed more shareholder value through share buybacks over the last few years than Bank of America.

Between 2003 and 2007, it repurchased a little over 768 million shares of its common stock at an average price of $52.05 per share, equating to a grand total of just under $40 billion.

A year and a half later, the Federal Reserve ordered it to raise $33.9 billion in new capital "in order to weather two years of the most severe economic circumstance."

It did so, and then some, by issuing 3.5 billion new shares in 2009 at an average price of $13.47 per share for a grand total of $47.5 billion.

4- GENERAL MOTORS: G.M. had many buybacks before the financial crisis, totaling $20.4 billion from 1986 to 2002.

5- GE After buying back more than 50 billion in the preceding 10 years of company stock in 2008 GE was forced to sell stock convertible at $22 with a 10 percent dividend to Warren Buffet in the financial crisis, and also issued 12 billion in common stock, that provided nearly as many shares as were previously retired. Buying stock at 40 and reissuing stock in single digits is what GE seems to most excel at

Just a few years before AIG, GE and Bank of AMerica were among the largest companies in capitalization.
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Old 05-11-2019, 10:35 AM   #18
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My main problem with buybacks are as follows:

1. Are they resulting in a meaningful reduction in the total number of outstanding shares or are they just offsetting some stock option compensation packages that would dilute existing shares if there wasn’t a corresponding buyback?

2. Is a company indiscriminately buying shares because they have cash and either don’t know what to do with it or worse trying to give the illusion that earnings are steadily growing when in fact they are reliant on a reduction in share count to see meaningful positive trends in earnings per share?

3. Is the company strategically buying back shares during periods of undervalued share prices or are they insistent on buying shares at a regular interval without any regard to valuation or better alternative uses for that capital?

For me, dividends are much more preferable but I’ve always been a dividend growth investor so that may just be my bias. The beauty of dividends is that they are not results of creative accounting practices- you actually have to have the cash to pay shareholders. Yes, dividends can be cut or eliminated but companies in general seem to avoid those situations as much as possible.

I’m not against buybacks. If done for the right reasons at the right times they are incredible tools to boost shareholder value. I guess I’ve just seen too many examples of companies using them inefficiently to spend capital I’m just soured on the idea as a general rule.
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Old 05-11-2019, 12:25 PM   #19
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My main problem with buybacks are as follows:

1. Are they resulting in a meaningful reduction in the total number of outstanding shares or are they just offsetting some stock option compensation packages that would dilute existing shares if there wasnít a corresponding buyback?

2. Is a company indiscriminately buying shares because they have cash and either donít know what to do with it or worse trying to give the illusion that earnings are steadily growing when in fact they are reliant on a reduction in share count to see meaningful positive trends in earnings per share?

3. Is the company strategically buying back shares during periods of undervalued share prices or are they insistent on buying shares at a regular interval without any regard to valuation or better alternative uses for that capital?

For me, dividends are much more preferable but Iíve always been a dividend growth investor so that may just be my bias. The beauty of dividends is that they are not results of creative accounting practices- you actually have to have the cash to pay shareholders. Yes, dividends can be cut or eliminated but companies in general seem to avoid those situations as much as possible.

Iím not against buybacks. If done for the right reasons at the right times they are incredible tools to boost shareholder value. I guess Iíve just seen too many examples of companies using them inefficiently to spend capital Iím just soured on the idea as a general rule.

The answer to all your questions is the same...


YES and NO...



All companies do it for different reasons and for different results which run to both sides of each question...
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