Skip to main content

Stock Buybacks



Thinking this through.

What happens to the value of shares of public stock if the company buys some of the stock back in the marketplace?

Think of it first as a simple accounting matter, and let's assume for simplicity's sake that the actual or potential buyers of the stock in the marketplace (who constitute the market demand) know and care about the book value on the balance sheet: that is, the equity as defined by the formula Assets - Liabilities = Equity.

Suppose the company has 1,000 shares of stock outstanding, each selling for $50. Its market capitalization, then, is $50,000. 

Now, it uses some of its own cash (an asset) to buy back some of the shares of stock. This decreases the amount of stock still available to a would-be buyer.  So if 100 shares are retired and 900 are left, as a first approximation -- assuming demand for the stock stays the same, we might well expect the value of those to increase to $55.55 per.

BUT something else has taken place, too. The company has depleted itself of cash. If it offered no premium on the market value of those shares, it bought 100 shares at $50 each, depleting itself of $5,000 worth of cash.

Since A - L = E, we would of course expect this hit to the asset side of the balance sheet to show up as a reduction in equity too. We've assumed the buyers care about such things. Why would the market not notice this and adjust for it?

Since the equity (book value) is reduced by the amount that the cash is reduced than the company is no longer worth $50,000: it is worth $45,000.

There are now 900 shares outstanding of stock in a company with a book value of $45,000. If that is reflected in the market value, then the market value will end up at: $50. Which is where we started.

Second approximation, then, the buyback should have no consequence at all for stock price, because the two effects one would immediately presume it will have (lessening the supply of the stock in circulation and lessening the book value of the company, thus the market demand for the stock) would exactly offset one another.  

As a third approximation, there is this: Palak Raval.

Comments

Popular posts from this blog

Great Chain of Being

One of the points that Lovejoy makes in the book of that title I mentioned last week is the importance, in the Neo-Platonist conceptions and in the later development of the "chain of being" metaphor, of what he calls the principle of plenitude. This is the underlying notion that everything that can exist must exist, that creation would not be possible at all were it to leave gaps.

The value of this idea for a certain type of theodicy is clear enough.

This caused theological difficulties when these ideas were absorbed into Christianity.  I'll quote a bit of what Lovejoy has to say about those difficulties:

"For that conception, when taken over into Christianity, had to be accommodated to very different principles, drawn from other sources, which forbade its literal interpretation; to carry it through to what seemed to be its necessary implications was to be sure of falling into one theological pitfall or another."

The big pitfalls were: determinism on the on…

A Story About Coleridge

This is a quote from a memoir by Dorothy Wordsworth, reflecting on a trip she took with two famous poets, her brother, William Wordsworth, and their similarly gifted companion, Samuel Taylor Coleridge.



We sat upon a bench, placed for the sake of one of these views, whence we looked down upon the waterfall, and over the open country ... A lady and gentleman, more expeditious tourists than ourselves, came to the spot; they left us at the seat, and we found them again at another station above the Falls. Coleridge, who is always good-natured enough to enter into conversation with anybody whom he meets in his way, began to talk with the gentleman, who observed that it was a majestic waterfall. Coleridge was delighted with the accuracy of the epithet, particularly as he had been settling in his own mind the precise meaning of the words grand, majestic, sublime, etc., and had discussed the subject with William at some length the day before. “Yes, sir,” says Coleridge, “it is a majestic wate…