What Corporate Buybacks Mean for Shareholders

By Ernest Hamilton

Mar 10, 2021 10:55 AM EST

What Corporate Buybacks Mean for Shareholders(What Corporate Buybacks Mean for Shareholders) (Credit: Getty Image)

Caroline Valetkevitch and Stephen Culp of Yahoo! Finance explored investor optimism due to the rise of corporate buybacks. Now, corporate buybacks, or what in the financial statements is reported as "corporate repurchases", is essentially what happens when a company buys back its own shares. So, if a company has 100 shares and earns $100 in profit for a given year, then that company's earnings per share are $1. Let's say this occurred in 2020 for this imaginary company. Now, if in 2021, this company repurchases 20 shares, the number of shares outstanding falls to 80. Meanwhile, its earnings per share rise to $1.25, even if the company has not grown profits. A knock-on effect of buybacks is that the fractional ownership of each shareholder increases. For example, if you owned 10 of those 100 shares, your stake would be 10%, which would rise to 12.5% when the number of outstanding shares was reduced to 80. 

Yahoo! Finance discusses the fact that corporate buybacks in the United States have been on the rise for a very long time. Indeed, they have become so important that the biggest source of equity demand in the United States comes from corporate buybacks. As you can imagine, earnings took a huge hit, with the broader economy suffering from record write-downs. WIth earnings fallings, naturally, many companies were forced to reduce dividends or put them on hold completely. 

The possibility of renewed corporate buybacks, though likely not immediately to pre-pandemic levels, will enthuse many investors, as investors have come to think of corporate buybacks as the new dividends. They also indicate that corporate America is regaining its health and confidence. Yahoo! Finance cites Netflix and other investment banks as having announced their intent to repurchase shares. Indeed, corporate buybacks among the members of the S&P 500 have steadily risen, from $102 billion in the third quarter of 2020 to $116 billion in the fourth. Share repurchases for 2020 stood at $505 billion. This is still down from 2019 figures wherein the S&P 500 posted share repurchases of $182 billion in the fourth quarter. In 2018, the S&P 500 set a record $806 billion in corporate buybacks for the year, with $223 billion of that in the final quarter of the year. Experts predict that corporate buybacks will reach $651 billion in 2021.

Clearly, this is something that is gathering momentum. As aforementioned, share repurchases are the most important source of equity demand, providing support for share prices. A rise in corporate buybacks would not only increase earnings per share, they would, in the near-term, also boost an already strong stock market.

One side effect of corporate buybacks is that book value per share declines. Book value refers to the assets under a company's control. So for example, you will know that when going through the corporate formalities needed to establish a company, that company will of course control certain assets, assets which have a value. The value of those assets, the book value, can be shared among the shareholders. One of those assets could be cash. If the company uses cash to buy back its own shares, it reduces its book value per share, even though in doing so it increases earnings per share. Buybacks do not, then, create long-term shareholder value. They can though prevent the destruction of economic value, if the buybacks occur because the company does not have avenues to invest its cash holdings. The question is, with so many companies announcing share buybacks, what is their motivation? Is it an indication that they do not have adequate growth pathways, or is this a way of manipulating earnings per share in an environment where many firms are not growing profits?

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