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One issue Im surprised never comes up in discussion of buybacks vs. dividends is, apart from the tax issue, whether buybacks drive stock prices up because of ho

One issue Im surprised never comes up in discussion of buybacks vs. dividends is, apart from the tax issue, whether buybacks drive stock prices up because of how large orders to buy stock at market price interact with the outstanding order book - ie that in a buyback you buy specifically from those of the current shareholders who attribute the lowest valuation to the stock at any given time. To simplify lets say 2 mutual funds each hold 50% of the stock of a corp. Mutual Fund A values the stock (ie is willing to sell at) $100, and mutual fund B is willing to sell at $120. Other potential buyers value the stock at $99 or less. The company decides to buyback 50% of its stock. It buys all of A’s stock, and thereby drives the new market price to $120. Meaning it drives up the market price even before you consider the effect of reducing the # of outstanding shares (fewer shares > higher EPS > higher stock price at a given P/E multiple). Of course, in the real world stockholding is less concentrated, the gap between valuations in the order book wouldn’t be so wide, shortsellers would also play a role and over time one would argue that efficient-markets-hypothesis factors in. But still... any thoughts?

kgwgk 8y ago
Buybacks are the natural state of the market... They push prices higher, or more likely they support prices if the company takes an opportunistic approach to shares repurchase. The problem is when the reporting season comes and they cannot do it: https://www.bloomberg.com/news/articles/2018-04-02/stocks-lose-critical-buyer-at-worst-time-as-selloff-picks-up https://www.bloomberg.com/news/articles/2018-04-02/stocks-lo...
OscarCunningham 8y ago
> Meaning it drives up the market price even before you consider the effect of reducing the # of outstanding shares (fewer shares > higher EPS > higher stock price at a given P/E multiple). These aren't two separate effects. The interaction between the buyback and the order-book is the mechanism through which the stock price is adjusted to take into account the smaller number of shares.
- kgwgk 8y ago
  Not really. If the company buys $100mn in shares or any other market participant buys $100mn in shares the stock price adjustment caused by the interaction between these orders and the order book will be the same. In one case the market will learn later that the share count has been reduced. In the other case no share count reduction will happen.
  - OscarCunningham 8y ago
    Your comment caused me to spend a bit longer thinking about this. I think I was wrong before and that in fact there's no effect at all of reducing the number of shares. If a company buys back 10% of its shares then it needs to spend 10% of its market-cap to do so. So company is now worth 90% of what it was, and there are 90% as many shares. So the share price stays the same. But there's also a second-order effect of the buyback on the share price. If the buyback is a wise thing to do (the shareholders can make better use of the cash than the business) then the shares should be more valuable after than before. I think it's this rise in the price that corresponds to the effect of buying the shares on the order book.
    - kgwgk 8y ago
      You are right that there is no "magical" effect in doing buybucks. The price stays the same. But it will go up from there as the company continues to make money. If the net income remains constant, the EPS will be ~10% higher. When the company accumulates again the cash that it just paid the price of the stock will be ~10% higher than before (at constant PE ratio). In the case of dividends, the price goes down. If the company distributes 10% of its market-cap as dividends, the price will go down 10% (actually less because a 10% dividend represents less that that to the recipients after taxes). And as time goes by the price will recover. If the net income (and therefore the EPS) remains constant, the stock price will get back to the original price when they accumulate again the cash they just distributed (at constant PE ratio). Still, my point was that the long-term effect of the capital allocation choice (which cannot be anticipated by the market until they know that it has been made, or at least that it is going to be made, but in any case the information is not being incorporated into prices at the precise time of the actual transactions) is not the same as the short-term market effect. The capital allocation is usually implemented through a market operation but it doesn't even have to be the case (they could get the shares in an off-market operation, a real example is company A buying another company B which has a stake in A, they can then eliminate those shares). And even if it is done in the market, the effect on the price would be the same if any other party (let's say the Saudi Arabia sovereign fund) decides to buy a large position in the stock. If the buyback is a wise thing to do, you say, the price of the stock should be higher and the price is adjusted through the open-market repurchasing of shares. The problem is that if the buyback is not a wise thing to do, the market effect of the buyback is still to push prices up!

kgwgk 8y ago

Buybacks are the natural state of the market... They push prices higher, or more likely they support prices if the company takes an opportunistic approach to shares repurchase. The problem is when the reporting season comes and they cannot do it: https://www.bloomberg.com/news/articles/2018-04-02/stocks-lose-critical-buyer-at-worst-time-as-selloff-picks-up https://www.bloomberg.com/news/articles/2018-04-02/stocks-lo...

OscarCunningham 8y ago

> Meaning it drives up the market price even before you consider the effect of reducing the # of outstanding shares (fewer shares > higher EPS > higher stock price at a given P/E multiple). These aren't two separate effects. The interaction between the buyback and the order-book is the mechanism through which the stock price is adjusted to take into account the smaller number of shares.

kgwgk 8y ago
Not really. If the company buys $100mn in shares or any other market participant buys $100mn in shares the stock price adjustment caused by the interaction between these orders and the order book will be the same. In one case the market will learn later that the share count has been reduced. In the other case no share count reduction will happen.
- OscarCunningham 8y ago
  Your comment caused me to spend a bit longer thinking about this. I think I was wrong before and that in fact there's no effect at all of reducing the number of shares. If a company buys back 10% of its shares then it needs to spend 10% of its market-cap to do so. So company is now worth 90% of what it was, and there are 90% as many shares. So the share price stays the same. But there's also a second-order effect of the buyback on the share price. If the buyback is a wise thing to do (the shareholders can make better use of the cash than the business) then the shares should be more valuable after than before. I think it's this rise in the price that corresponds to the effect of buying the shares on the order book.
  - kgwgk 8y ago
    You are right that there is no "magical" effect in doing buybucks. The price stays the same. But it will go up from there as the company continues to make money. If the net income remains constant, the EPS will be ~10% higher. When the company accumulates again the cash that it just paid the price of the stock will be ~10% higher than before (at constant PE ratio). In the case of dividends, the price goes down. If the company distributes 10% of its market-cap as dividends, the price will go down 10% (actually less because a 10% dividend represents less that that to the recipients after taxes). And as time goes by the price will recover. If the net income (and therefore the EPS) remains constant, the stock price will get back to the original price when they accumulate again the cash they just distributed (at constant PE ratio). Still, my point was that the long-term effect of the capital allocation choice (which cannot be anticipated by the market until they know that it has been made, or at least that it is going to be made, but in any case the information is not being incorporated into prices at the precise time of the actual transactions) is not the same as the short-term market effect. The capital allocation is usually implemented through a market operation but it doesn't even have to be the case (they could get the shares in an off-market operation, a real example is company A buying another company B which has a stake in A, they can then eliminate those shares). And even if it is done in the market, the effect on the price would be the same if any other party (let's say the Saudi Arabia sovereign fund) decides to buy a large position in the stock. If the buyback is a wise thing to do, you say, the price of the stock should be higher and the price is adjusted through the open-market repurchasing of shares. The problem is that if the buyback is not a wise thing to do, the market effect of the buyback is still to push prices up!