> A share buyback should be stock price neutral at the time it is done - there is no change in the value of the company. Cash goes out the door while also reducing shareholder equity.
There is no change in the value of the company. There are fewer shares outstanding though which means each existing share is worth more.
Share buybacks are absolutely a good deal for shareholders when a company is undervalued. When a company is overvalued, dividends reward shareholders better. If a company is fairly valued, it largely depends on tax rates and whether the shareholder funds are in a tax sheltered account. [1]
The problem comes in when executive compensation is based on share-price. Executives have massive motivation to buyback shares even when the company is overvalued. So long as share buybacks are on the table as an option, share value should never affect executive compensation or there is an inherent conflict of interest.
Ideally, the company would hire a third party with no conflict of interest to determine best ways to return money to shareholders.
[1] Tax incentives around dividends and buybacks are overdue for some reform.
> There is no change in the value of the company. There are fewer shares outstanding though which means each existing share is worth more.
The company's value decreases by the buyback amount. Share price (ignoring positive signalling impact) remains unchanged.
E.g. Company has $100 market cap with 10 outstanding shares at $10/share. Company does $10 buyback. Afterwards, company has $90 market cap with 9 outstanding shares at $10/share.
Company shares are valued based on future earnings. If the company is undervalued, the value of remaining shares increases over time. As the future value of the shares taken off market is greater than the current share value. Lots of companies have gone this route; market cap increases over time and existing shares increase in value.
If the company is overvalued, the shareholders just get screwed as the company is buying back shares which are already worth less than the future value of the companies earnings.
"There are fewer shares outstanding though which means each existing share is worth more."
That worth has been reduced by the cash paid for the retired shares. So yes, each shareowner has a slightly larger percentage ownership but of a slightly smaller company. The way this can change is if future profitability exceeds that which is already expected and part of the current price.
> That worth has been reduced by the cash paid for the retired shares.
It doesn't work this way. Companies aren't valued based on how much cash they have on hand. They are valued based on the future value of their returns which should be several orders of magnitude more than whatever cash they are spending on buybacks.
Apple has spent over $500b on buybacks over the past 10 years. By your logic, they should be smaller than they were when they started. A healthy company spending money on a buyback doesn't affect their ability to earn money in the future which is the basis for the companies valuation.
Likewise, dividends don't devalue a company. A company is valued based on their future earning capacity, not based on how much cash they have on hand.
> Once you correct your understanding of this, you will see that GP is explaining things correctly.
If a companies liquid assets are more than a small fraction of the companies value, then management is doing something seriously wrong. Some valuation formulas punish companies who have excessive cash on hand.
Going to quote my original reply because I'm tired of repeating this point.
> Share buybacks are absolutely a good deal for shareholders when a company is undervalued.
If a company is undervalued, then the share price is less than the future earnings of the company. The value of their future earnings might be $1.01. If they buy back shares, they are paying $1 for $1.01 worth of future earnings which are realized by existing shareholders.
A classic example of this is Apple buying back shares over the past 5-10 years or so (less clear now with share prices being so high).
If a company is valued higher than the companies future earnings or the company needs to take on debt to buyback shares then it doesn't make any sense.
It’s not really possible to give buybacks and dividends the same tax treatment unless we make massive changes to how volatile assets like public equities are taxed, and any of those changes would come with their own set of knock on effects. It’s not obvious to me that buyback tax reform is something we should obviously do.
I'm not passionate about this, but just wanted to point out that it is entirely possible to tax buybacks nearly the same as taxing dividends. Existing shareholders would be taxed based on the amount spent on the buybacks, just as if they'd been paid a dividend and bough back shares themselves.
> It’s not obvious to me that buyback tax reform is something we should obviously do.
The big reason I think it should be reformed it creates lopsided incentives which reward some shareholders more than others. As I said above, I do think it could be better, but I'm not super passionate about it.
No that’s the part that’s hugely disruptive. If a stock goes up you’re forced to sell to pay a tax bill. Then if it goes down the next year the government has to cut you a huge check. Very messy.
There is no change in the value of the company. There are fewer shares outstanding though which means each existing share is worth more.
Share buybacks are absolutely a good deal for shareholders when a company is undervalued. When a company is overvalued, dividends reward shareholders better. If a company is fairly valued, it largely depends on tax rates and whether the shareholder funds are in a tax sheltered account. [1]
The problem comes in when executive compensation is based on share-price. Executives have massive motivation to buyback shares even when the company is overvalued. So long as share buybacks are on the table as an option, share value should never affect executive compensation or there is an inherent conflict of interest.
Ideally, the company would hire a third party with no conflict of interest to determine best ways to return money to shareholders.
[1] Tax incentives around dividends and buybacks are overdue for some reform.