5 ms·

Buying back stock only creates value for shareholders if the stock is trading for less than its intrinsic value. Above that price buybacks destroy shareholder v

Buying back stock only creates value for shareholders if the stock is trading for less than its intrinsic value. Above that price buybacks destroy shareholder value. Executives are doing this to meet performance targets and get bonuses. Not to allocate capital efficiently.

jcfrei 7y ago
I don't think I can follow your argument. What's intrinsic value? The market is supposed to arrive at a fair value for a stock (and there's no reason to assume it doesn't because that would create arbitrage opportunities). If you buyback at the fair value no shareholder value is created or destroyed, the only change is in the ownership of the assets and future dividends.
- voxic11 7y ago
  Don't stock buybacks basically transfer wealth from the company to the shareholders? The major advantage this has over other means of transferring wealth is that shareholders get to realize their gains with only capital gains tax applied, rather then the much higher dividend tax rate.
  - JackFr 7y ago
    > Don't stock buybacks basically transfer wealth from the company to the shareholders? That is to say from the shareholders to themselves.
  - csomar 7y ago
    Plus they might chose not to get taxed by holding the stock.
  - jdsully 7y ago
    No the shareholders own the company so they “own” the cash either way. Buybacks and dividends return control of the cash back to shareholders so they can allocate it elsewhere.
    - walshemj 7y ago
      Not exactly a 10% buy back is not 100% guaranteed the same return as a 10% dividend - and this Ignores the time value of money.
      - aliston 7y ago
        Theoretically an x billion dollar dividend results in the exact same outcome for a shareholder as an x billion dollar stock buy back. Not sure the time value of money factors in.
      - nostrademons 7y ago
        Dividends are not guaranteed either - companies can and do suspend dividends whenever they have cash flow or profitability problems.
  - sib 7y ago
    No - if the price is $X, then the shareholder is exchanging $X in shares for $X in cash. That's not a transfer of wealth.
  - dahdum 7y ago
    Most dividends are qualified and thus taxed the same as capital gains.
    - Scoundreller 7y ago
      Maybe to the IRS. But if you’re a foreigner owning US stocks, they’re taxed much differently. Right off the bat, the IRS withholds 15-30% of dividende paid to foreigners. Not so with cap gains. And, at least in Canada, US stock dividends are taxed at full personal tax rates. Cap gains are cap gains, foreign or domestic in Canada. So I’m all for cutting dividends and doing buybacks.
    - walshemj 7y ago
      Not really dividends are taxed as income which Is normally higher than capita gains for good reasons. Your basically taking more risk with capital that income to reward you for putting your capital at risk
  - robocat 7y ago
    Another advantage for many different kinds of shareholders (foreign, non-profit, tax-loss-holders, long-term-holders etc) could be that the taxation rules for buybacks are specific to the shareholder. Dividend and company taxes can really screw certain types of shareholders.
    - Scoundreller 7y ago
      Very true for Canadians. It also depends on what kind of account the holdings are in. In retirement accounts, it’s all the same. In our « tax-free savings accounts », we still get hit by IRS withholding taxes that we can’t write off against any corresponding taxes (because there aren’t any). In a cash account, US dividends are taxed as if they were bond interest. Capital gains also let stockholders pick and choose which year to crystallize their gains. I don’t plan on selling some funds until I have a low tax year.
  - mpalczewski 7y ago
    No tax rates are now the same(don't nerdify this, it's correct enough for the point). The reason is that dividends are sticky. You lower the dividend, and stock holders will notice(and sell). You buy back stock, and then later stop, few will notice. Buybacks support stock prices really well for executive stock based compensation, they can sell into the buying which they know exactly when it will happen.
    - hrez 7y ago
      Executive stock based compensation also dilutes shares which buybacks balance back. Shareholders may get way less in value from buybacks than execs. on topic https://www.ft.com/content/0f863da4-0b6e-11ea-b2d6-9bf4d1957a67 https://www.ft.com/content/0f863da4-0b6e-11ea-b2d6-9bf4d1957...
    - laurencerowe 7y ago
      While the tax rates are the same the result is different since a shareholder can chose when to realize the gain. If you model dividend reinvestment vs share buy backs this taxation deferral is quite significant for the shareholder due to compounding effects. A simplistic illustration: Tax rate on cap gains and dividends is 20%. Inflation is zero. Company earns 10% of its market cap yearly in profits. Company's market cap is static over time. Scenario A: returns profits as share buy backs. Scenario B: returns profits as dividends on which the shareholder pays tax and reinvests the rest in company stock. At the end of the scenario, sell all stock paying capital gains tax due (nothing to pay on scenario B since stock price has not changed.) Even though dividends and capital gains are taxed at the same rate, scenario A beats scenario B by 10% over 10 years and 45% over 30 years.
  - rumanator 7y ago
    > Don't stock buybacks basically transfer wealth from the company to the shareholders? There's some confusion in your comment. The company is already property of the shareholder. The shareholder holds shares of the company. Thus, the assertion that stock buybacks transfer wealth from the company to the shareholder is a tautology because the wealth from the company is already the wealth of the shareholder.
    - ethbro 7y ago
      In the individual case, some number of shares in the company is property of the shareholder. Perhaps more accurate would be to say they liquidate part of a company's wealth (the broader value of all assets owned by the company) into stock price (the value at which a share can be sold on the open market). From this perspective it seems fair to say that they transfer wealth from company control to shareholder control.
      - dodobirdlord 7y ago
        I think it is best to characterize it as being an opportunity for shareholders to part ways with the company, taking their share of ownership as cash and moving on. Of course, all of these characterizations are the same and describe the same event, but I find this one the least inflammatory. It makes it clear that no transfer of wealth is happening, that buybacks don't meaningfully effect share price, etc.
  - phkahler 7y ago
    Don't stock buybacks basically transfer wealth from the company to the shareholders? No. It drives up the share price. That's nice for people who want to sell, but does little for the long term. A company that has dividends might be able to increase them if the number of shares is reduced, but buybacks are often done by companies that dont have dividends. There are companies doing both and I'm not sure what to make of that.
  - dragonwriter 7y ago
    > Don't stock buybacks basically transfer wealth from the company to the shareholders? The major advantage this has over other means No, because the shareholders already have the wealth that is in the company, since stock is a form of wealth. It makes some part of the wealth shareholders already have liquid, though.
  - notSupplied 7y ago
    No it is merely a act of divestiture of capital / wealth that shareholders already own. What is peculiar is that this act has nothing to do with running a company well in the long term, yet is the most immediate way executives can improve their "performance based compensation". Execs seem to have found a hack around stock based compensation that biases companies towards divestiture over investment, and the short-term minded shareholders are onboard with this scheme at the expense of long-term minded shareholders. This looks largely like a bug in the executive compensation system...I'm curious what kinds of fixes are going to come out of the world of MBA academia.
- Retric 7y ago
  Companies have non public information and therefore can more accurately price the value of their stocks relative to the market than investors can. This may not apply in the long term, but insider trading is illegal due to this information asymmetry. In the extreme case of a disclosure that will tank the stock price their current investors would be better if the company sold new shares ahead of that announcement. This would then dilute the loss across more investors. Though the ethical issues should be obvious. Buybacks are simply the opposite of issuing new stock which happens to have tax advantages.
  - jfengel 7y ago
    Out of curiosity... are stock buybacks subject to any kind of insider trading rules? I'd imagine that they'd be needed if the executives own stock in the company (or whose compensation is otherwise tied to the performance of the stock).
    - Retric 7y ago
      There are separate rules, but they operate in the opposite direction. The SEC rules give a safe harbor, a type of immunity for enforcement actions for share price manipulation, to firms whose insiders sell when a buyback is announced. https://www.marketwatch.com/story/secs-jackson-says-research-hes-conducted-shows-corporate-insiders-are-using-buybacks-to-cash-out-2019-03-06 https://www.marketwatch.com/story/secs-jackson-says-research...
- aczerepinski 7y ago
  The market is frequently irrational. Short squeezes, news cycles, macro economic events, etc can cause a stock to diverge from a reasonable calculation of its discounted future earnings. In short, the efficient market hypothesis is incorrect. It's why value investors like Warren Buffett have been able to get rich buying underpriced stocks. It isn't all that unusual for stocks to double or halve during the course of a year. Acknowledging this is why Berkshire is authorized to buy back stock only up to a certain multiple of book value. More companies should follow suit.
- ttcbj 7y ago
  Most securities have a real intrinsic value that can be calculated the future cash flows to owners from that security. For bonds, the number of variables in this calculation makes this easier to understand: If you have a bond that will pay you $100 one time in one year, then the intrinsic value of that bond is slightly less than $100 (because there is risk you won't be repaid, there is inflation, and there is a cost to waiting to get your $100). If you pay $50 for it, you are getting a very good deal relative to intrinsic value, and if you pay $150, you are getting a bad deal. This same calculation can be made for stocks based on their dividends and any terminal value from an eventual acquisition. These calculations fluctuate more because dividends are variable. The parent's comment is right though, its something buffet often observes: If a company buys back stock far about its intrinsic value, it is transferring wealth from current shareholders to now ex-shareholders. If it buys it back below intrinsic value, then it is transferring it from now ex-shareholders to shareholders. There is actually a wonderful story that illustrates this. Try searching for "buffet pritzker Rockwood & Co arbitrage". The short version is that Rockwood & Co was sitting on a massive supply of very valuable chocolate, and its stock price didn't reflect the value of that chocolate. Pritzker controlled the company, and announced it would redeem shares for chocolate (a buy-back in chocolate). Arbitrage traders then bought up shares at the low price, redeemed them for more valuable chocolate, and pocketed the difference. BUT, what they didn't calculate was that the amount of chocolate that remained inside the company was far larger than the amount that was going out to the departing shareholders. Essentially, the chocolate 'payments' for stocks were far below the intrinsic value of the company. So, every time an arbitrage trader traded in shares for chocolate (at a profit to them) Pritzker was actually getting far richer by retaining his remaining shares. Everyone was winning, but Pritzker was winning far more. In the end, Pritzker retained a much higher ownership percentage of an only slightly smaller stockpile of very valuable chocolate, and made a lot doing it. I think I saw the full version of this story in the biography of Buffet, but I am not sure. It is super fun. It illustrates why a management team that is buying back shares below intrinsic value is helping the remaining owners increase their wealth, and vice versa.
  - why_only_15 7y ago
    Why didn't Rockwood & Co just sell the chocolate in bulk to someone else? I have to imagine the arbitrage traders were taking it at a discount because they're probably bad at selling chocolate, and they're probably reselling them too. Why didn't Rockwood & Co just do that instead?
- TomMckenny 7y ago
  If price=value by definition then that means there is no such thing as market manipulation, buy definition. And that the value of exchange traded tulips was in actual fact enormous at one point. The fact that arbitration actually exists is because there is a disconnect between price and wealth generated solely by information differential. And beyond an exchange, that, merely because their parent's opportunity cost differs greatly, raising one infant is in fact vastly more valuable than another essentially identical infant. I would suggest that price is not identical to value, it's just that the market is usually the best way to determine a value.
- pmart123 7y ago
  Not really. Arbitrage opportunities typically occur when the risk and opportunity can be defined such as spread and liquidity across exchanges or contracts, euro denominated vs USD denominated assets, etc. intrinsic value is much more subjective. Yet, there are times where stocks might drift above or below their intrinsic value significantly. For instance, many CPG companies have become bond proxies due to rates, where the price only makes sense with a 3-4% discount rate.
AnthonyMouse 7y ago
> Buying back stock only creates value for shareholders if the stock is trading for less than its intrinsic value. Above that price buybacks destroy shareholder value. That's assuming the value of the cash is the same in the hands of the corporation as the shareholders. But if the corporation has nothing it needs the money for internally then the cash is nothing but a liability that it has to waste resources trying to figure out how to externally invest, or have it get infected with principal-agent problems and empire building. The shareholders as more directly self-interested parties may be better equipped to find investments with a better risk-adjusted return. Moreover, if the company is successful then needlessly holding the cash causes the stock to trade for less than its intrinsic value, because holding cash lowers the company's overall ROI from the above-market returns its actual business is generating to the average of that and the presumably market-average rate of return it collects on the cash. Returning the cash causes the company's share price to adjust (i.e. rise) to reflect the higher returns from its actual business once they're no longer being diluted.
- cellular 7y ago
  But what if there is no ROI, like high tech companies that pay no dividends?!
  - dodobirdlord 7y ago
    Investors then try to model what the future dividends of the company will look like once it establishes a dividend, or what price it is likely to eventually get acquired for as a lump-sum payment.
bluecalm 7y ago
Buybacks don't create value. They return the value created by the company to stockholders. They are form of dividends you're just automatically reinvesting it into the company stock instead of getting cash.
- JimboOmega 7y ago
  Yeah, wanted to respond this way. Buybacks are basically a one off dividend. Companies want to return money to shareholders, but don't want to commit to returning a certain amount regularly, so they do buybacks. Whether the stock is over or undervalued is a bit besides the point, actually. It's a direct flow of cash to investors, that any investor can take advantage if they think the current price is too high (or not, if the price is too low)
beaner 7y ago
Capital allocation doesn't have to be the goal for them to actually be doing that in effect.
Danieru 7y ago
Buybacks are not about creating value, they are about transferring value which already exists back to the legal owners. Banning buybacks would leave money in the hands of the managers/administrators. Only suggest this if you feel CEOs are under paid and control too weak.
cellular 7y ago
But "buying back stock" only temporarily creates value for the shareholder. If they don't immediately sell the stock, the price will return to what it was before they buyback, because no underling value in the company has increased (especially when dividends are never payed out, like most high tech companies that are always in the "growing" phase : looking at you FB, Goog etc).

jcfrei 7y ago

I don't think I can follow your argument. What's intrinsic value? The market is supposed to arrive at a fair value for a stock (and there's no reason to assume it doesn't because that would create arbitrage opportunities). If you buyback at the fair value no shareholder value is created or destroyed, the only change is in the ownership of the assets and future dividends.

voxic11 7y ago
Don't stock buybacks basically transfer wealth from the company to the shareholders? The major advantage this has over other means of transferring wealth is that shareholders get to realize their gains with only capital gains tax applied, rather then the much higher dividend tax rate.
- JackFr 7y ago
  > Don't stock buybacks basically transfer wealth from the company to the shareholders? That is to say from the shareholders to themselves.
- csomar 7y ago
  Plus they might chose not to get taxed by holding the stock.
- jdsully 7y ago
  No the shareholders own the company so they “own” the cash either way. Buybacks and dividends return control of the cash back to shareholders so they can allocate it elsewhere.
  - walshemj 7y ago
    Not exactly a 10% buy back is not 100% guaranteed the same return as a 10% dividend - and this Ignores the time value of money.
    - aliston 7y ago
      Theoretically an x billion dollar dividend results in the exact same outcome for a shareholder as an x billion dollar stock buy back. Not sure the time value of money factors in.
    - nostrademons 7y ago
      Dividends are not guaranteed either - companies can and do suspend dividends whenever they have cash flow or profitability problems.
- sib 7y ago
  No - if the price is $X, then the shareholder is exchanging $X in shares for $X in cash. That's not a transfer of wealth.
- dahdum 7y ago
  Most dividends are qualified and thus taxed the same as capital gains.
  - Scoundreller 7y ago
    Maybe to the IRS. But if you’re a foreigner owning US stocks, they’re taxed much differently. Right off the bat, the IRS withholds 15-30% of dividende paid to foreigners. Not so with cap gains. And, at least in Canada, US stock dividends are taxed at full personal tax rates. Cap gains are cap gains, foreign or domestic in Canada. So I’m all for cutting dividends and doing buybacks.
  - walshemj 7y ago
    Not really dividends are taxed as income which Is normally higher than capita gains for good reasons. Your basically taking more risk with capital that income to reward you for putting your capital at risk
- robocat 7y ago
  Another advantage for many different kinds of shareholders (foreign, non-profit, tax-loss-holders, long-term-holders etc) could be that the taxation rules for buybacks are specific to the shareholder. Dividend and company taxes can really screw certain types of shareholders.
  - Scoundreller 7y ago
    Very true for Canadians. It also depends on what kind of account the holdings are in. In retirement accounts, it’s all the same. In our « tax-free savings accounts », we still get hit by IRS withholding taxes that we can’t write off against any corresponding taxes (because there aren’t any). In a cash account, US dividends are taxed as if they were bond interest. Capital gains also let stockholders pick and choose which year to crystallize their gains. I don’t plan on selling some funds until I have a low tax year.
- mpalczewski 7y ago
  No tax rates are now the same(don't nerdify this, it's correct enough for the point). The reason is that dividends are sticky. You lower the dividend, and stock holders will notice(and sell). You buy back stock, and then later stop, few will notice. Buybacks support stock prices really well for executive stock based compensation, they can sell into the buying which they know exactly when it will happen.
  - hrez 7y ago
    Executive stock based compensation also dilutes shares which buybacks balance back. Shareholders may get way less in value from buybacks than execs. on topic https://www.ft.com/content/0f863da4-0b6e-11ea-b2d6-9bf4d1957a67 https://www.ft.com/content/0f863da4-0b6e-11ea-b2d6-9bf4d1957...
  - laurencerowe 7y ago
    While the tax rates are the same the result is different since a shareholder can chose when to realize the gain. If you model dividend reinvestment vs share buy backs this taxation deferral is quite significant for the shareholder due to compounding effects. A simplistic illustration: Tax rate on cap gains and dividends is 20%. Inflation is zero. Company earns 10% of its market cap yearly in profits. Company's market cap is static over time. Scenario A: returns profits as share buy backs. Scenario B: returns profits as dividends on which the shareholder pays tax and reinvests the rest in company stock. At the end of the scenario, sell all stock paying capital gains tax due (nothing to pay on scenario B since stock price has not changed.) Even though dividends and capital gains are taxed at the same rate, scenario A beats scenario B by 10% over 10 years and 45% over 30 years.
- rumanator 7y ago
  > Don't stock buybacks basically transfer wealth from the company to the shareholders? There's some confusion in your comment. The company is already property of the shareholder. The shareholder holds shares of the company. Thus, the assertion that stock buybacks transfer wealth from the company to the shareholder is a tautology because the wealth from the company is already the wealth of the shareholder.
  - ethbro 7y ago
    In the individual case, some number of shares in the company is property of the shareholder. Perhaps more accurate would be to say they liquidate part of a company's wealth (the broader value of all assets owned by the company) into stock price (the value at which a share can be sold on the open market). From this perspective it seems fair to say that they transfer wealth from company control to shareholder control.
    - dodobirdlord 7y ago
      I think it is best to characterize it as being an opportunity for shareholders to part ways with the company, taking their share of ownership as cash and moving on. Of course, all of these characterizations are the same and describe the same event, but I find this one the least inflammatory. It makes it clear that no transfer of wealth is happening, that buybacks don't meaningfully effect share price, etc.
- phkahler 7y ago
  Don't stock buybacks basically transfer wealth from the company to the shareholders? No. It drives up the share price. That's nice for people who want to sell, but does little for the long term. A company that has dividends might be able to increase them if the number of shares is reduced, but buybacks are often done by companies that dont have dividends. There are companies doing both and I'm not sure what to make of that.
- dragonwriter 7y ago
  > Don't stock buybacks basically transfer wealth from the company to the shareholders? The major advantage this has over other means No, because the shareholders already have the wealth that is in the company, since stock is a form of wealth. It makes some part of the wealth shareholders already have liquid, though.
- notSupplied 7y ago
  No it is merely a act of divestiture of capital / wealth that shareholders already own. What is peculiar is that this act has nothing to do with running a company well in the long term, yet is the most immediate way executives can improve their "performance based compensation". Execs seem to have found a hack around stock based compensation that biases companies towards divestiture over investment, and the short-term minded shareholders are onboard with this scheme at the expense of long-term minded shareholders. This looks largely like a bug in the executive compensation system...I'm curious what kinds of fixes are going to come out of the world of MBA academia.
Retric 7y ago
Companies have non public information and therefore can more accurately price the value of their stocks relative to the market than investors can. This may not apply in the long term, but insider trading is illegal due to this information asymmetry. In the extreme case of a disclosure that will tank the stock price their current investors would be better if the company sold new shares ahead of that announcement. This would then dilute the loss across more investors. Though the ethical issues should be obvious. Buybacks are simply the opposite of issuing new stock which happens to have tax advantages.
- jfengel 7y ago
  Out of curiosity... are stock buybacks subject to any kind of insider trading rules? I'd imagine that they'd be needed if the executives own stock in the company (or whose compensation is otherwise tied to the performance of the stock).
  - Retric 7y ago
    There are separate rules, but they operate in the opposite direction. The SEC rules give a safe harbor, a type of immunity for enforcement actions for share price manipulation, to firms whose insiders sell when a buyback is announced. https://www.marketwatch.com/story/secs-jackson-says-research-hes-conducted-shows-corporate-insiders-are-using-buybacks-to-cash-out-2019-03-06 https://www.marketwatch.com/story/secs-jackson-says-research...
aczerepinski 7y ago
The market is frequently irrational. Short squeezes, news cycles, macro economic events, etc can cause a stock to diverge from a reasonable calculation of its discounted future earnings. In short, the efficient market hypothesis is incorrect. It's why value investors like Warren Buffett have been able to get rich buying underpriced stocks. It isn't all that unusual for stocks to double or halve during the course of a year. Acknowledging this is why Berkshire is authorized to buy back stock only up to a certain multiple of book value. More companies should follow suit.
ttcbj 7y ago
Most securities have a real intrinsic value that can be calculated the future cash flows to owners from that security. For bonds, the number of variables in this calculation makes this easier to understand: If you have a bond that will pay you $100 one time in one year, then the intrinsic value of that bond is slightly less than $100 (because there is risk you won't be repaid, there is inflation, and there is a cost to waiting to get your $100). If you pay $50 for it, you are getting a very good deal relative to intrinsic value, and if you pay $150, you are getting a bad deal. This same calculation can be made for stocks based on their dividends and any terminal value from an eventual acquisition. These calculations fluctuate more because dividends are variable. The parent's comment is right though, its something buffet often observes: If a company buys back stock far about its intrinsic value, it is transferring wealth from current shareholders to now ex-shareholders. If it buys it back below intrinsic value, then it is transferring it from now ex-shareholders to shareholders. There is actually a wonderful story that illustrates this. Try searching for "buffet pritzker Rockwood & Co arbitrage". The short version is that Rockwood & Co was sitting on a massive supply of very valuable chocolate, and its stock price didn't reflect the value of that chocolate. Pritzker controlled the company, and announced it would redeem shares for chocolate (a buy-back in chocolate). Arbitrage traders then bought up shares at the low price, redeemed them for more valuable chocolate, and pocketed the difference. BUT, what they didn't calculate was that the amount of chocolate that remained inside the company was far larger than the amount that was going out to the departing shareholders. Essentially, the chocolate 'payments' for stocks were far below the intrinsic value of the company. So, every time an arbitrage trader traded in shares for chocolate (at a profit to them) Pritzker was actually getting far richer by retaining his remaining shares. Everyone was winning, but Pritzker was winning far more. In the end, Pritzker retained a much higher ownership percentage of an only slightly smaller stockpile of very valuable chocolate, and made a lot doing it. I think I saw the full version of this story in the biography of Buffet, but I am not sure. It is super fun. It illustrates why a management team that is buying back shares below intrinsic value is helping the remaining owners increase their wealth, and vice versa.
- why_only_15 7y ago
  Why didn't Rockwood & Co just sell the chocolate in bulk to someone else? I have to imagine the arbitrage traders were taking it at a discount because they're probably bad at selling chocolate, and they're probably reselling them too. Why didn't Rockwood & Co just do that instead?
TomMckenny 7y ago
If price=value by definition then that means there is no such thing as market manipulation, buy definition. And that the value of exchange traded tulips was in actual fact enormous at one point. The fact that arbitration actually exists is because there is a disconnect between price and wealth generated solely by information differential. And beyond an exchange, that, merely because their parent's opportunity cost differs greatly, raising one infant is in fact vastly more valuable than another essentially identical infant. I would suggest that price is not identical to value, it's just that the market is usually the best way to determine a value.
pmart123 7y ago
Not really. Arbitrage opportunities typically occur when the risk and opportunity can be defined such as spread and liquidity across exchanges or contracts, euro denominated vs USD denominated assets, etc. intrinsic value is much more subjective. Yet, there are times where stocks might drift above or below their intrinsic value significantly. For instance, many CPG companies have become bond proxies due to rates, where the price only makes sense with a 3-4% discount rate.

AnthonyMouse 7y ago

> Buying back stock only creates value for shareholders if the stock is trading for less than its intrinsic value. Above that price buybacks destroy shareholder value. That's assuming the value of the cash is the same in the hands of the corporation as the shareholders. But if the corporation has nothing it needs the money for internally then the cash is nothing but a liability that it has to waste resources trying to figure out how to externally invest, or have it get infected with principal-agent problems and empire building. The shareholders as more directly self-interested parties may be better equipped to find investments with a better risk-adjusted return. Moreover, if the company is successful then needlessly holding the cash causes the stock to trade for less than its intrinsic value, because holding cash lowers the company's overall ROI from the above-market returns its actual business is generating to the average of that and the presumably market-average rate of return it collects on the cash. Returning the cash causes the company's share price to adjust (i.e. rise) to reflect the higher returns from its actual business once they're no longer being diluted.

cellular 7y ago
But what if there is no ROI, like high tech companies that pay no dividends?!
- dodobirdlord 7y ago
  Investors then try to model what the future dividends of the company will look like once it establishes a dividend, or what price it is likely to eventually get acquired for as a lump-sum payment.

bluecalm 7y ago

Buybacks don't create value. They return the value created by the company to stockholders. They are form of dividends you're just automatically reinvesting it into the company stock instead of getting cash.

JimboOmega 7y ago
Yeah, wanted to respond this way. Buybacks are basically a one off dividend. Companies want to return money to shareholders, but don't want to commit to returning a certain amount regularly, so they do buybacks. Whether the stock is over or undervalued is a bit besides the point, actually. It's a direct flow of cash to investors, that any investor can take advantage if they think the current price is too high (or not, if the price is too low)

beaner 7y ago

Capital allocation doesn't have to be the goal for them to actually be doing that in effect.

Danieru 7y ago

Buybacks are not about creating value, they are about transferring value which already exists back to the legal owners. Banning buybacks would leave money in the hands of the managers/administrators. Only suggest this if you feel CEOs are under paid and control too weak.

cellular 7y ago

But "buying back stock" only temporarily creates value for the shareholder. If they don't immediately sell the stock, the price will return to what it was before they buyback, because no underling value in the company has increased (especially when dividends are never payed out, like most high tech companies that are always in the "growing" phase : looking at you FB, Goog etc).