Bharat Bhise believes that for you to become a better
investor, you shouldn’t underestimate stock buybacks. Understanding what they
are and how they work can make you more money. A stock buyback is the
re-acqusition by a company of its own stock, representing a more flexible way
of returning money to shareholders. When a company buys it shares back, the
value of the shares often goes higher, which means that the investors are
making more money.
For example, if there are 100 shares in a company X and X is
worth $200, each share is worth $2. If the company buys back 10 shares, you’re
technically down to 90 shares outstanding. However, the company still birth
$200. Note that the equity value is unrelated to the share count and is based
on future profits. So with 90shares representing $200 in value, the share price
moves up to $2.22 from $2.
You might wonder why companies would buy its own stocks, but
it actually makes sense. A company has a certain amount of cash to spend for
the coming period for operating expenses and long-term investments. When they
have excess cash, it does not make sense to simply leave it there. The company
will want to put that money to work while getting the cash back to
shareholders. If the company buys its own stock back from the market, that same
cash is being funneled toward an asset that can appreciate. Repurchasing
outstanding shares can help a business reduce its cost of capital, benefit from
temporary undervaluation of the stock, consolidate ownership, inflate important
financial metrics or free up profits to pay executive bonuses. Shareholders
will see the shares they still hold move up in value. In this scenario,
everybody wins.
The next time a company initiates a buyback program, Bharat
Bhise recommends that you consider buying the stock.
