eli5 what are buybacks and how do they raise company profit?
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Company X has 100 stock shares, that currently cost about $100 each, this means that the entire company is worth $10,000.
During the last year company X has made a profit of $1,000, and intends to pay $500 back to the shareholders, they now have 2 options:
Option 1: Simply give each shareholder $5, which will result in every shareholder having a share worth $95 and $5 cash.
Option 2: Buy 5 of its own shares, meaning there’s now only a total of 95 shares, each worth ~$105.
In both scenarios, the total value is still $10,000, it’s just distributed in different ways.
Stock buybacks are when a company gives x% over the current value of a their own stock to buy it back from the current holder. Simple supply and demand takes over, less shares means each individual share is worth more.
So stock buybacks are done when the company calculates that the increase in price per share that they hold will be greater than the money spent on buying the stock
You have two good explanations about buybacks below, but neither say anything to address your question about how they raise company profits. They don’t. Profit is unaffected by a depletion of cash and recording the treasury stock in the net worth of the company. A buyback from an accounting standpoint affects the balance sheet only, not income or expenses. But a key measure like earnings per share (EPS) is certainly improved, not by increased profits but by there being less shares outstanding to spread the same profit over. Similarly, the P/E ratio can be improved, as well as ROE and ROA. These ‘profitability’ ratios are important to investors. But note, they are ratios of earnings compared to something else (to equity, to assets, etc.) and it is those parts of the ratio that are affected by the buyback to improve the ratio, not the profit itself.
First of all they do NOT raise company profit. A share buyback, is simply when a company uses leftover money to buy back shares of their own company from investors. The shareholders who remain now have a greater share of the company and the shares are worth more (in theory).
This is preferable to taking that same money and paying dividends to shareholders instead, since dividends are taxable and unrealized gains from share buybacks are not.
Buybacks do not raise company profit. They shrink the pool of shares in existence so that each remaining shareholder owns a larger percentage of the company than before. This makes the remaining shares more valuable.
Buybacks don’t raise company profit. They raise profit **per share**.
Imagine each share is owned by a different person and 10% of those people sell their shares back to the company. Now, the remaining shareholders each own 10% **more** of the company and are entitled to 10% **more** of the **same** company profits.
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