What happens to a stock market index when a record number of companies buy back a record number of their own shares from investors?
The question is relevant because 2013 was just such a year, and a good question to consider is how much stock prices could have been driven by a reduction in the number of shares issued to the public and their effect upon the standard tools that investors use to assess the performance of a company.
Also called share repuchases, Investopedia describes stock buybacks and the basic motivation behind them:
A program by which a company buys back its own shares from the marketplace, reducing the number of outstanding shares. Share repurchase is usually an indication that the company's management thinks the shares are undervalued. The company can buy shares directly from the market or offer its shareholder the option to tender their shares directly to the company at a fixed price.
The Harvard Business Review describes how share buybacks can affect the value of a company:
Buybacks affect value in two ways. First, the buyback announcement, its terms, and the way it is implemented all convey signals about the company's prospects and plans, even though few managers publicly acknowledge this. Second, when financed by a debt issue, buybacks can significantly change a company's capital structure, increasing its reliance on debt and decreasing its reliance on equity.
For investors though, the immediate impact of a company's share repurchase program is seen in measures like earnings per share. Investing Daily's Chad Fraser explains:
Companies have two main ways of returning cash to shareholders: buybacks and dividends. The latter are pretty straightforward: the company pays a certain amount for each stock held, usually on a quarterly basis.
Under a share buyback, a company purchases a certain number of its own shares. It may do this on the open market or by giving its shareholders the option to tender their stock to the firm, usually at a slight premium to the market price. It then cancels the purchased shares, reducing the total number outstanding and giving each shareholder a larger slice of the company.
Political Calculations is a site that develops, applies and presents both established and cutting edge theory to the topics of investing, business and economics.
Be the first to read Political Calculation's column. Sign up today and receive Townhall.com delivered each morning to your inbox.
Today, at 11:20 AM PT: Get the Market Movements in Advance: William's Edge Webinar for August 28th, 2014 | John Ransom
Today, at 11:20 AM PT: Get the Market Movements in Advance; Williams Edge Webinar for August 27th, 2014 | John Ransom
In Other News: Rare Sighting of the Elusive President Obama in His Natural Habitat, the Golf Course | Michael Schaus
Today, at 11:20 AM PT: Get the Market Movements in Advance; Williams Edge Webinar for August 25th, 2014 | John Ransom
In Other News: Law "Enforcer" Eric Holder Understands People's Mistrust of Law Enforcement | Michael Schaus