Trying to understand share buybacks...

FDa65rdk

I was reading an article about share buybacks recently and it stated that a buyback would lead to shareholders receiving greater earnings per share as the number of outstanding shares has fallen.

I’m sorry if this is a really stupid question but if a company buys back e.g. £100 million of shares wouldn’t the company then own those shares as assets?

Wouldn’t the company’s cash decrease by £100 million through buying the shares and the value of the shares they’ve bought back (as new assets) fluctuate with the share price?

I’m sure that the answer to both those questions is no – but I would be really interested in understanding why that is.

Why would a buyback strengthen a shareholder’s position with the company?

If Mr Smith owns 10% (let’s say 10,000 of the 100,000 shares owned in total by the shareholders) and the company buys back 20,000 shares, I presume it would be said that Mr Smith owns 12.5% of the company and is entitled to a greater share of the profits.

But why?

The shareholders own 80,000 shares in total but the company has the other 20,000 so why wouldn’t it be said that Mr Smith still owns 10% because there are 100,000 shares altogether?

Why do the shares that were bought back not count as part of the total?

It almost seems as though the bought back shares vanish into thin air like they no longer exist or count as an asset.

Apologies again if I’m being stupid but I would really like to get my head round this!

callum9999

FDa65rdk said:

I was reading an article about share buybacks recently and it stated that a buyback would lead to shareholders receiving greater earnings per share as the number of outstanding shares has fallen.

I’m sorry if this is a really stupid question but if a company buys back e.g. £100 million of shares wouldn’t the company then own those shares as assets?

Wouldn’t the company’s cash decrease by £100 million through buying the shares and the value of the shares they’ve bought back (as new assets) fluctuate with the share price?

I’m sure that the answer to both those questions is no – but I would be really interested in understanding why that is.

Why would a buyback strengthen a shareholder’s position with the company?

If Mr Smith owns 10% (let’s say 10,000 of the 100,000 shares owned in total by the shareholders) and the company buys back 20,000 shares, I presume it would be said that Mr Smith owns 12.5% of the company and is entitled to a greater share of the profits.

But why?

The shareholders own 80,000 shares in total but the company has the other 20,000 so why wouldn’t it be said that Mr Smith still owns 10% because there are 100,000 shares altogether?

Why do the shares that were bought back not count as part of the total?

It almost seems as though the bought back shares vanish into thin air like they no longer exist or count as an asset.

Apologies again if I’m being stupid but I would really like to get my head round this!

Don't worry it's not a stupid question (though one that could easily be answered with a Google search!).

The company doesn't hold on to shares it buys back - they are cancelled. Their cash will decrease, but that doesn't necessarily mean they'll pay out any less in dividends.

Aretnap

FDa65rdk said:

The shareholders own 80,000 shares in total but the company has the other 20,000 so why wouldn’t it be said that Mr Smith still owns 10% because there are 100,000 shares altogether?

Why do the shares that were bought back not count as part of the total?

If the shares did still exist then Mr Smith would still own a greater proportion of the company. He would still own his own shares - and his shareholding would also mean that he effectively owned a proportion of the 20000 shares that the company held.

A proportion of any dividend paid to shareholders would also be paid straight back to the company, meaning that the company can afford to pay larger dividends per share without depleting its cash reserves so much.

In practice though as above the bought back shares are cancelled which makes things nice and simple. They do vanish into thin air - meaning that Mr Smith does indeed now own 10000 shares or of 80000, or 12.5%.

TheAble

The earnings of the company are unchanged but the share count is reduced. Since those earnings are divided among fewer shares as a result, then continuing shareholders earn more per share.

Thumbs_Up

Lloyds bank has just recently completed a equity buyback plan. If my figures are correct they have spent £2 billion to remove from the market almost 4 and a bit billion shares. The share price still is a dog’s dinner.  

TheAble

Thumbs_Up said:

Lloyds bank has just recently completed a equity buyback plan. If my figures are correct they have spent £2 billion to remove from the market almost 4 and a bit billion shares. The share price still is a dog’s dinner.  

If the company is buying back shares then it should hope for the share price to languish. More shares bought back for the same money.