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Finance: Why Do Companies Buy Back Their Own Stock? 21 Views
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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
- 00:00
And finance allah shmoop why do companies buy back their
- 00:05
own stock Well sometimes wall street simply gets it wrong
- 00:09
Investors place of value on a company based on whatever
- 00:12
price its stock is trading at and when investors do
- 00:15
get it wrong on the low side cos they're usually
Full 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
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