eli5 how stock buy backs work for corporations?


Why do corporations buy back their own stock? What is the strategy in this?

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Stock Buy backs are very similar to paying dividends. Its a way to give money directly back to the shareholds. It really only matters for people who hold very large amounts of shares though, which are often insiders and large institional holders (such as investment firms like a Blackrock or Vanguard).

A company “buys back” shares off the market, which increase the share price of the stock. An increase price of the stock, means every share you own is a little more valuable than it was yesterday.

Another way to do this is dividends, and its the opposite — it decrease the price of each share. When a company pays dividends, it directly gives money to shareholders, and the company value decrease by that exact amount (which means the share price goes down).

Dividends -force- your shareholders to take income. Its basically like selling a portion of your shares. There are times you may want to do this or not. A stock buy back does not force your shareholders to have an income event, instead it just makes each share more valuable.

To add, there are several reasons to buy back stocks. One of them is for the company to take back some of the equity. Especially if they feel like the stock is undervalued, they can claw back the equity at a discount. One major criticism comes up when the topic comes up is when companies are given money from the government and they use it to buy back instead of use it for actually helpful things like keeping workers on or innovating. Imagine being advantaged in such a way and then taking actions to take back equity from the market so they can increase their share to take advantage of the continued benefits of that advantage.

You have a company with 100 shares outstanding and report earnings of $100, or $1/share.

You buy back 10 shares, now only have 90 shares outstanding. Next quarter, you again report earnings of $100, but now that’s $1.11/share. Assuming that your PE remains constant, the share price should rise accordingly, creating more shareholder value for those remaining shareholders.