Finance: Why Do Companies Buy Back Their Own Stock?

Why do companies buy back or repurchase their own stock? Companies buy back their own stock because it helps them to increase the value of stock and improve the “conditions,” we’ll say, for their current investors. After a buyback, there are less outstanding shares, so those shares are worth more and those investors own a larger part of the company.

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Transcript

00:18

the first to realize the disconnect and they're usually wise

00:21

to proactively take advantage of it in buying back their

00:24

own stock That's the basic quick and dirty But the

00:26

details answer for why companies buy back their own stocks

00:29

a bit more complex companies who have excess cash used

00:32

to just pay a dividend and when they still had

00:35

more cash than they needed for upgrading those smelting plants

00:38

and improving their assembly line efficiency and perfecting the quality

00:42

of their pooper scoopers while they simply up to their

00:45

dividend But then tax laws changed Basically tax rates went

00:48

higher Acme hemorrhoid cream supply company makes a billion dollars

00:52

in operating profit a year and it pays three hundred

00:54

million bucks in taxes to net seven hundred million dollars

00:58

in earnings but then pays three hundred million dollars in

01:00

dividends back to shareholders but then shareholders pay tax on

01:04

that three hundred million well in california for example shareholders

01:07

would pay something like one hundred million dollars in taxes

01:10

on those three hundred million in dividend distributions so the

01:13

company just earned a billion box and four hundred million

01:16

of it went back to the government well eventually companies

01:20

and individuals got sick of such a heavy tax burden

01:23

So instead of paying out taxable dividends companies began using

01:27

that excess cash to buy back their own stock Instead

01:30

buy backs are not taxed so that entire three hundred

01:33

million dollars that might have gone out for dividends had

01:36

the company used it all for buybacks would be some

01:38

thirty percent more efficient Keep in mind that buying back

01:42

stock shrinks the pie of ownership That is if a

01:45

company has two hundred fifty million shares outstanding and earned

01:48

five hundred million bucks in a year each year for

01:51

five years But each year the company bought back ten

01:54

million shares than at the end of those five years

01:57

The company would have just two hundred million shares out

02:00

standing while still earning the same five hundred million bucks

02:03

Initially the company was earning two dollars a share about

02:06

with fewer shares that two dollars per share grew to

02:09

fifty a share So even on flat earnings the company

02:12

was able to grow its earnings per share just by

02:15

buying back its own stock So yeah all of this

02:18

is nice and can work well if the company trades

02:20

at a low price to earnings Multiple low means that

02:24

the company believes it will be around for the next

02:26

fifty years or so It earns a dollar share and

02:29

trades for ten dollars a share and has no debt

02:31

and is growing revenue steadily it in a five six

02:33

seven Eight percent a year and lives in an industry

02:36

which this year for some stupid reason is out of

02:38

favor with young wall street investors So the stock which

02:41

used to trade a twenty five times earnings now trades

02:44

at only ten times and with the company believing it'll

02:46

still grow earning sizably in the future at ten times

02:50

this year's earnings nine times next years and eight times

02:52

the following year's earnings the company looks like a bargain

02:55

if the's low multiples So let's say a company has

02:58

no cash and no debt and will earn a dollars

03:00

Share this year in trades for ten bucks a share

03:03

Well if it took half of its earnings to buy

03:06

back stock and if the stock price stated ten bucks

03:08

and the earning stayed flat at a buck a share

03:11

well they'd have fought back the entire company in twenty

03:14

years In reality with fewer shares and even just flat

03:17

earnings i'ii earnings that aren't growing a company's stock price

03:20

would almost always go up So in a sense this

03:22

is a way for a company to force ah higher

03:24

stock price or force wall street to recognize its value

03:28

So all of this is great In theory the reality

03:31

is that many companies think they're better than they really

03:33

are and spend billions buying back their own stock at

03:36

twenty bucks a share after it fell from eighty on

03:39

ly to see the stock Ten bucks a share two

03:41

years later the wall street pros do nothing all day

03:44

over even figure out the trends that shaped stock prices

03:46

in the future So it's a rare company that can

03:48

see that vision more clearly than the droves of professional

03:52

investors all around him of course there's a second possibility

03:55

Maybe a company just has a sentimental attachment to its 00:03:58.453 --> [endTime] stock and the missing reunited And it feels good