Stock Buybacks are in Season

10 July 2007

Stock buybacks are back in fashion in today’s markets, and they are driving shareholder value.Dollar_sign
Home Depot, Target, and IBM are just a few examples of distinguished organizations that have recently announced significant share buyback programs.

Quick review – share buybacks are when companies announce that they will be buying their own stock on the open market with the intention of cancelling the shares and thus reducing the total number of shares outstanding. 

Shareholders love stock buybacks for two reasons:
1) When companies buyback their own shares it tends to form somewhat of a floor for the stock price. In other words, the buying of the stock (depending on how large scale the buying is) can move the stock price higher.
2) When a company cancels the shares it has bought back that inherently increases the value of the remaining shares. Think of a pie that now has fewer pieces. Each recipient gets a larger piece.

So why are stock buybacks so popular right now?
A good argument is that interest rates are still quite low, thus cash is cheap, and taking on debt to fund a shareholder buyback is a good way of increasing shareholder value. 

Others may say that shareholder pressure on management is forcing companies to buyback stock and create shareholder value that is not otherwise created by good performance and subsequent share price appreciation.

Short term shareholders will say “who cares, you are creating immediate shareholder value and that’s what matters”.

Longer term shareholders, on the other hand, may argue that the cash used to buy back the stock should be used to fund the growth of the company (example – reinvested into the operations of the company, funding capital expenditures, or funding for acquisitions).

It’s an interesting debate, but one that is far from controversial.  In the end, all shareholders are receiving a positive return as a result of these buybacks.  Controversy and happy/rich shareholders are rarely seen together.

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