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Global giant companies have started a massive war of share buybacks. Since the beginning of 2021, $Facebook(FB.US)$ , $Apple(AAPL.US)$ , $Alphabet-A(GOOGL.US)$ , $Microsoft(MSFT.US)$ and $McDonald's(MCD.US)$ launched share buyback programs that breaks the record.
What is a stock buyback? Is it good or bad? Will it influence our investing decision？Let's take a closer look.
What is a stock buyback?
A stock buyback refers to a company's purchase of shares of its own stock from shareholders, reducing the number of shares on the market and increasing the value of remaining shares.
Why does a company buyback its shares?
Buying back shares is one of the easiest ways for a company to create value for its shareholders. Hereare some potential reasons for a company to buyback:
1. The stock is undervalued.
2. The company has too much cash on hand.
3. Management is confident about future operations.
4. A buyback is more tax-friendly than a cash dividend.
5. Limited opportunities to invest (other than itself).
6. Try to support the stock price (just try).
What are the effects of shares repurchase？
1. Reduce shares outstanding
When shares are repurchased by a company, these shares are no longer outstanding and the total number of shares outstanding in that company is reduced accordingly. Hence, if the company decides to cancel the repurchased shares, the ownership of each share will automatically increase.
According to Buffett, shareholders will benefit when the company's revenue continues to expand but the number of shares outstanding continues to decline.
2. Increase earnings per share (EPS)
Shares repurchase also has an effect on increasing earnings per share. Imagine, if a company buys back half of its shares and keeps total earnings the same, earnings per share will double. As we know:
3. Push up the stock price
Stock Price = PE * EPS. If a stock's PE ratio hold still and EPS goes up (due to repurchase), its stock price will go up eventually.
What are the risks involved?
Every coin has two sides, just as not every share buyback is perfect.
Although share buybacks will drive up some financial ratios (i.e. EPS, ROE, ROIC), the value is not created through organic growth (increasing output and enhancing sales internally). Relying too much on buybacks may not be a permanent arrangement.
In addition, if a company decides to buyback when the stock price is extremely overvalued, the buyback may harm shareholder's interest.
A real-world example: Apple
Apple is one of the biggest repurchase player in the human history. Since beginning to repurchase shares in 2013, Apple has spent $460 billion to buyback its shares.
The market cap of Apple is 2.43 trillion USD, about 4 times of that of 2016. However, the stock price of AAPL increases more than 500% during the same peroid. Without saying, the share buyback adds up the long-term value of the stock.
Besides the current stock price, the share buy back changes the financial statement of Apple. Since 2016, the time that Buffett starts buying, the EPS of Apple keeps a higher growth rate than its net income.
Apple's buyback program boosts the overall effectiveness of its operation. In the past 5 years, the return on equity (ROE) of Apple rockets massively, from 36.9% in 2016 to 73.69% in 2020, showing that it can pile inactive cash into shareholder's value at a record level.
What's your takeaway?
Will share buybacks influence our buying or selling decisions? Which stocks do you favor the most?
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