what are stock buybacks?

Question

And why do people compare using them to the Great Depression stock crash? I don’t understand and I tried.

In: 3

Answer 1

Stocks are owning ‘part’ of a company. You, and X of your new buddies all put up some capital to fund a venture, and are entitled to 1/X of the resulting company. If you and 99 other people each put up 1000$ for a single share in a shop, that shops starting capital is 100,000.

The desire is that these ventures are profitable, and if it is, the most tax-advantaged route is generally for the company to reinvest the profits. So if your shop produces 10K in profit, and they use it to expand the shop, you get increased value in your share.

However, there will be times that it does not make sense to do that. Sometimes a company wishes to expand faster than it can grown on its own, or is in a downturn and needs liquidity. The options are basically taking debt or issuing new shares, and the latter dilutes the ownership (instead of 100 owners, you may now have 200).

On the inverse, if a company has extra cash and doesn’t want to reinvest it, it can pay down debt, issue a dividend, or do a stock buyback. Dividends are simply saying “I have an extra 100$, each shareholder gets 1$”, while a stock buyback is saying “I’m going to buy 100$ worth of stock off the open market in the name of the company.”, after such a buy, there may be only 98 shareholders left, concentrating ownership.

Both stock buybacks and dividends are very beneficial to the functioning of the market as a whole. Just because it makes sense to invest 100K into a business doesn’t mean it makes sense to invest 300K into the same business, and if the business is doing well, it can be generating more in profit than is sensible to invest in that business sector.

It generally gets vilified by people who would rather the company reinvest the profits, creating demand/jobs in the business. It doesn’t mean it isn’t better for the investors to take those profits and invest them in other businesses with more potential.

tl;dr: It is just the inverse of selling new stock to raise capital, it is buying old stock to reduce capital. It is an alternative to giving dividends. Because markets are forward-looking, if the company disagrees with the market on its future prospects (and thus thinks it is ‘undervalued’), there will be more value in a stock buyback than a dividend.