eli5: what are stock buybacks, why are they generally considered a bad thing (for most of us), and what’s the rationale for having it?
In: 63
Shares represent ownership.
If you own 1 share of a company that has 1000 outstanding shares, you own 0.1% of the company.
When the company buys back 100 shares and you choose not to sell to them, there are now only 900 shares in circulation and your ownership would then be 0.11%. As you now own a larger piece of the pie, you’re entitled to more dividends, voting right, and everything that comes with ownership. Your 1 share is now more valuable and can fetch higher peice.
There is nothing bad about stock buyback by itself. However, spending money on stock repurchase meaning the company won’t reinvest and expand the business. Certain politicians hate this because the company might be producing essential goods (despite their claim to the contrary). For example, oil companies are distributing dividend and do buyback instead of drilling for new rigs, which causes shortage (old wells are depleting but no new well is built) and prices of everything to increase.
Shares represent ownership.
If you own 1 share of a company that has 1000 outstanding shares, you own 0.1% of the company.
When the company buys back 100 shares and you choose not to sell to them, there are now only 900 shares in circulation and your ownership would then be 0.11%. As you now own a larger piece of the pie, you’re entitled to more dividends, voting right, and everything that comes with ownership. Your 1 share is now more valuable and can fetch higher peice.
There is nothing bad about stock buyback by itself. However, spending money on stock repurchase meaning the company won’t reinvest and expand the business. Certain politicians hate this because the company might be producing essential goods (despite their claim to the contrary). For example, oil companies are distributing dividend and do buyback instead of drilling for new rigs, which causes shortage (old wells are depleting but no new well is built) and prices of everything to increase.
They aren’t always bad. There are legitimate uses for doing buybacks that have positive effects.
1. It can reduce costs. Buying back shares and not increasing dividend prices means less of the company’s money is being paid out to investors. If it isn’t using the money for growth because of economic or market conditions, but is still highly profitable, it can be better to buy back the shares rather than continue paying dividends on all of them. In this situation there’s a financial disadvantage to having so many outstanding shares.
2. Can protect the company during a recession/downturn. Instead of having to just cut dividends and suffer a mass sell off from short term investors, the company can do buybacks prior to or at the onset of an economic downturn to soften the blow. This use can leave the company with more operating cash during the downturn if it’s not in a position to reduce dividend payments without suffering catastrophic devaluation.
3. Undervalued stocks can be bought by the company and later reissued when the stock price is high to acquire new capital without having to issue new shares. This one can be tricky, but because a lot of investors tend to be short-sighted it’s very possible for a company’s stock price to be significantly undervalued (or bad press, frivolous lawsuits, etc.. can cause an undervalued stock).
The company can take advantage of this situation and do a buyback while the prices are low, which will help shrink the valuation gap and then resell those shares later to bring in more cash.
4. It can make their stock more attractive to investors. Stocks compete with each other (it’s a market, after all). The act of doing a buyback can signal to investors that the company no longer needs excess capital and/or is in a good enough financial position that it can afford buybacks. That increases investor confidence.
You can read a bit more in depth at [investopedia](https://www.investopedia.com/ask/answers/042015/why-would-company-buyback-its-own-shares.asp)
Note: The “here’s how they can be bad” are pretty well covered by other posts here, so I did not include them. This isn’t a “make them seem rosey and good” post, but a balance post. Please do read other posts in here to see how they can be (and often are) a negative.
They aren’t always bad. There are legitimate uses for doing buybacks that have positive effects.
1. It can reduce costs. Buying back shares and not increasing dividend prices means less of the company’s money is being paid out to investors. If it isn’t using the money for growth because of economic or market conditions, but is still highly profitable, it can be better to buy back the shares rather than continue paying dividends on all of them. In this situation there’s a financial disadvantage to having so many outstanding shares.
2. Can protect the company during a recession/downturn. Instead of having to just cut dividends and suffer a mass sell off from short term investors, the company can do buybacks prior to or at the onset of an economic downturn to soften the blow. This use can leave the company with more operating cash during the downturn if it’s not in a position to reduce dividend payments without suffering catastrophic devaluation.
3. Undervalued stocks can be bought by the company and later reissued when the stock price is high to acquire new capital without having to issue new shares. This one can be tricky, but because a lot of investors tend to be short-sighted it’s very possible for a company’s stock price to be significantly undervalued (or bad press, frivolous lawsuits, etc.. can cause an undervalued stock).
The company can take advantage of this situation and do a buyback while the prices are low, which will help shrink the valuation gap and then resell those shares later to bring in more cash.
4. It can make their stock more attractive to investors. Stocks compete with each other (it’s a market, after all). The act of doing a buyback can signal to investors that the company no longer needs excess capital and/or is in a good enough financial position that it can afford buybacks. That increases investor confidence.
You can read a bit more in depth at [investopedia](https://www.investopedia.com/ask/answers/042015/why-would-company-buyback-its-own-shares.asp)
Note: The “here’s how they can be bad” are pretty well covered by other posts here, so I did not include them. This isn’t a “make them seem rosey and good” post, but a balance post. Please do read other posts in here to see how they can be (and often are) a negative.
Most people are focusing on what buybacks are and not necessarily how they can be a bad thing. I’ll give a concrete example: Airlines.
Airlines in recent years have done tons of stock buy backs. However buy backs only benefit people who own the stock. 90% of stocks are owned by the wealthiest 10% of Americans. This means that buybacks only help the rich. Meanwhile the airlines have very old and outdated technology. The Southwest Airlines disaster around Christmas was caused by outdated and inefficient systems that desperately need to be upgraded. Instead of making upgrades to improve the company Southwest does stock buybacks so rich people who own stock make more money while millions of Americans who need to use the airline get stranded at Christmas and are unable to see their families.
A stock buyback is when a public company buys back a portion of the outstanding (publicly owned) shares of their own stock.
Investors generally like this because stock buybacks happen at a premium, meaning that their shares are bought out for more than their current value.
To society in general stock buybacks are a negative because the Company is taking it’s excess cash and using it to do nothing but enrich shareholders.
What would be best for society/economy is if the Company instead used that cash to invest in new tech/research or simply paid their workers more/hired more workers. All of those activities would stimulate long term economic growth.
A stock buyback is when a public company buys back a portion of the outstanding (publicly owned) shares of their own stock.
Investors generally like this because stock buybacks happen at a premium, meaning that their shares are bought out for more than their current value.
To society in general stock buybacks are a negative because the Company is taking it’s excess cash and using it to do nothing but enrich shareholders.
What would be best for society/economy is if the Company instead used that cash to invest in new tech/research or simply paid their workers more/hired more workers. All of those activities would stimulate long term economic growth.
Most people are focusing on what buybacks are and not necessarily how they can be a bad thing. I’ll give a concrete example: Airlines.
Airlines in recent years have done tons of stock buy backs. However buy backs only benefit people who own the stock. 90% of stocks are owned by the wealthiest 10% of Americans. This means that buybacks only help the rich. Meanwhile the airlines have very old and outdated technology. The Southwest Airlines disaster around Christmas was caused by outdated and inefficient systems that desperately need to be upgraded. Instead of making upgrades to improve the company Southwest does stock buybacks so rich people who own stock make more money while millions of Americans who need to use the airline get stranded at Christmas and are unable to see their families.
To raise money a company sells shares or percentages of ownership in the company (there’s different types of shares but let’s keep it simple for now).
If the company makes a lot of money and has money to spare, one way to spend that money is to buy back some of the outstanding shares. In theory this can be useful if a company wants more autonomy and wants to reduce the influence of investors, but in reality that almost never happens. Because as you buy up those stocks and remove them from the market there are fewer shares to buy, which makes people value them more and causes the price of the stock to rise.
It’s an easy way to raise the value of your company which is beneficial for those that own stocks and appealing for new employees that might be offered stock options. But in reality it’s kind of market manipluation, it keeps investors happy while actually not making anything.
To raise money a company sells shares or percentages of ownership in the company (there’s different types of shares but let’s keep it simple for now).
If the company makes a lot of money and has money to spare, one way to spend that money is to buy back some of the outstanding shares. In theory this can be useful if a company wants more autonomy and wants to reduce the influence of investors, but in reality that almost never happens. Because as you buy up those stocks and remove them from the market there are fewer shares to buy, which makes people value them more and causes the price of the stock to rise.
It’s an easy way to raise the value of your company which is beneficial for those that own stocks and appealing for new employees that might be offered stock options. But in reality it’s kind of market manipluation, it keeps investors happy while actually not making anything.
Latest Answers