ELI5, what is the buyback of shares?


ELI5, what is the buyback of shares?

In: 2

The company *buys back* some amount *shares* from stockholders.

I think it’s rather self explanatory so I think it might be beneficial if you expand on your question and say what part is confusing you.

Imagine if 5 people owned a business together.

One of them wants out of the business. He could just sell his share to one of the four other owners or he could sell a quarter of his share of the company to each of the 4 others.

This can get complicated really fast when more and more people own a company together though.

An alternative is that the company itself uses its profits to buy back the share of this one guy in itself.

The endresult is the same: each owners share in the company has grown a bit.

A company doing share buy back basically pays some of its owners to give up their stake of ownership in the company so that the other owners own more of it.

It gets controversial when companies sue their profit to buy back lots of shares and then a short while later claim they need a governemtn bailout because they have no money left.

They indirectly transferred the profits to the shareholders by using the buyback to make the value of each remaining share higher.

It doesn’t help that the people running the company often get bonuses in the form of shares in the company, so they profit directly from increasing the size of those shares via buybacks.

A company is usually owned by a number of people, each recording their ownership in the form of shares, but how many shares exist is actually decided by the company.

So the company can issue new shares, so that people who used to won 100% of the company between them now own 80%, because a new 20% of shares have been made that have gone to other people.

Or it can buy shares off people and make them cease to exist, which has the opposite effect:

Instead of having 1000 shares in circulation, you can buy 100 of them off shareholders.

Then you end up with 900 shares, meaning that each shareholder who refused to sell now owns more of the company proportionally than they did before, because each share is now 1/900 th of a company rather than 1/1000 th.

At the same time, this gives investors a choice; they can choose to sell their shares at the suggested price, or wait for a higher price later on as the shares grow in value, which means that giving shareholders money this way means you end up with more investors who are there long term.

One ways companies try to create more shareholder value is by buying shares that trade on the stock market and retire them, thereby increasing the fraction of ownership of each share remaining in hands of investors.

Say a company has profits of $1m and 1m shares outstanding, then earnings per share is $1, and if the company trades at a PE ratio of 20, then the stock would trade around $20/sh.

If the company buys back 200k shares, and 800k remain traded by investors, then the same $1m in profits is now $1.25/sh so a 20 PE would translate to a share price of about $25/sh.

the idea is in the name: the company is buying back their shares.

now why would you want ot do this? there are a few reasons:

1:the company is currently publicy traded but it wants ot get out of that. In order to do this legally, they need to converge all of the stock they released ot the public and own all of these shares.

2:the company is owned by a circle of shareholders and one of the shareholders wants out: they can sell their shares to the other holders, altenratively the company might wanna buy them back to retire the mfrom the market.

3(the less legal reason): they are doing as part of a an attempt ot short the stock. they are trying ot push the value of their stock up, by reducing the overall supply. a 1/500th share is more valuable than a 1/1000th share if the overall value of the company remains equal. hence more morally bankrupt actos can use this as a tool ot inlfuence market in their favor without outright commiting a crime.