Why do companies buy back their own shares?
In: Economics
Stock buy backs reduce the number of shares in existence thereby increasing the value of the remaining shares.
Doing a stock buyback is good for the investors because they either get cash for their shares, or their shares increase in value.
The reason it’s controversial is that companies have had a tendency lately to use government grants (like pandemic funds) to do stock buybacks instead of using it for their employees benefit.
In effect putting your tax dollars directly into the pockets of shareholders instead of supporting the workforce.
Shares represent a *share* of the company’s profits. If you own a share, you are entitled to receive a portion of the profits as *dividends*. Not all companies pay out dividends, because the money can instead be reinvested into the company. Think of, like, a delivery company that spends that money on more trucks so that next year profits *should* be higher. Famously, Amazon has been doing this for its entire existence.
Regardless, that’s what shares are – an agreement that you will get some of their profits if and when they have profits. Companies sell stocks to get cash immediately in order to run the business. Thinking back to our delivery company: when it was starting out, maybe they needed some quick cash to buy the first several trucks they needed in order to function. Although buying and trading and selling stocks can be complex, the concept is pretty straightforward – They get money now in exchange for the promise of paying you a percent of their profits later.
The company only gets money when they sell the stock the first time. Every other time the stock is bought and sold, the company gets nothing. It’s like a used book – the author only gets money the first time, they can’t track who is buying and selling and trading the book after that. However, the share still entitles whoever owns it a chunk of the profits. The company isn’t getting any money out of it, but they’re still paying money to it.
A stock buy-back returns the stock to the company’s ownership so that they don’t have to pay anyone that share of the profits anymore. That’s more money for the person or people who own the company, which includes everyone else who still owns their shares. They don’t buy more shares, but since the profits go up, they get more. Since there are fewer shares (and the profits they represent are higher), those shares are worth more so shareholders can sell them for more if they choose. It also means that the company can later sell those shares again if they need cash.
In this way, it’s the reverse of the initial sale: they’re *paying* money now in return for keeping money later.
The point of being a shareholder in a company is so that you will earn an income based on the profit of that company despite having done no work for the company. There are two ways the company can transfer that profit to its shareholders:
1) The company can pay a dividend in which all shareholders get a fixed amount of money per share that they own. Dividends usually provide a small but predictable, passive income and are historically what most stock investors were looking for. More modernly, large institutions with fixed payment obligations, such as pension funds, like to invest in companies that pay a decent dividend due to the predictable nature of the income.
2) The company can buy back shares. This will cause a short term increase in the demand for the company’s shares and a long term decline in the supply of the company’s shares. The result of this is that shareholders who want to cash their shares out are able to do so at a higher than normal price, while shareholders who want to hold onto their shares see the paper value of the shares increase.
The modern stock market has seen a shift towards speculative, gambling based investment. IE, the Wallstreetbets mentality is becoming more widespread, particularly among investors under the age of 35. Investors who are doing so by gambling don’t want a small but predictable return on their investment. They want large, unpredictable returns and the possibility of a large stock buyback better satisfies that investment strategy.
Something to keep in mind is that the shareholders of a company are the *owners* of that company and the company’s management is supposed to do what the shareholders want. If a significant percentage of the shareholders have invested in the company hoping for a large stock buyback so they can cash out, then that’s what the company is going to do.
Some great info here thanks!
A quick follow up: is the long term goal of buying back shares for the company to own itself entirely and not pay out dividends?
Let’s say you have 4 shareholders who own 1 share at 25% each. Now the company decides to buy back shares. So they buy back 1 share. Now they have 3 share holders who own 33%. Now you get a larger piece of the profit. It increases the ownership stake of the existing share holders.
Who votes company owned shares?
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