Share buybacks and the nasty world of the stock market
Today's topic is 'share buybacks'. You know what that is. That's when a company buys back its own shares from its own shareholders. Why? For various reasons too tedious to talk about on here. What you do need to know is that eventually, you'll be investing your hard-earned money in shares (either directly or through a managed fund) and your bottomline depends on how the companies you invested in manage their cash. One way they do this is through 'share buybacks'.
On the surface, a share buyback is good news for everyone - the investors (those who sell out and those who don't), the brokers and the company's management team. Why? Because the share price goes up (same amount of profit but less number of shares = more profit per shareholder = higher share price value).
However, research has shown that a company's share price spikes after a buyback but settles to a lower level soon after. By this time, the 'smaller' company has a weaker balance sheet i.e. the shareholders who stayed on are stuck with a dud company and the shareholders who sold would have gained more money in the long run had they stayed and demanded that the company make better use of its excess cash.
Why then do management push for a buyback program? Many reasons. But mostly to line their own pockets.
Fact: There is a strong correlation between the time a company announces a share buyback (share price goes up) and the time the management can exercise their share options (the right to buy shares at a certain price). i.e. option to buy at $5 and the shares are at $7 = quick $2 profit.
Moral of the story: If you want to make a quick buck, grab company annual reports and look at the date share options are due to be exercised. Buy shares months before those dates and watch the money roll in.
Disclaimer: I am not a financial adviser and I don't know your personal financial situation. Therefore, this quick buck strategy may not suit you and in fact, you might lose money! Besides, LJ is not an appropriate forum for financial tips and strategies. I am just doing revision for my exams. :P
Other notes: There are cases where the company is genuinely creating value by buying back shares. The final outcome depends on whether the buyback was financed through debt or equity or a bit of both, whether the company sold underperforming assets or cashcow operations to fund the purchase and what the investor's required rate of return is.
All I'm saying is that when you're at a shareholder meeting and the CEO announces there will be a $1.3 billion share buyback program, you should stand up and ask "How are you financing that?" and watch him tremble...
On the surface, a share buyback is good news for everyone - the investors (those who sell out and those who don't), the brokers and the company's management team. Why? Because the share price goes up (same amount of profit but less number of shares = more profit per shareholder = higher share price value).
However, research has shown that a company's share price spikes after a buyback but settles to a lower level soon after. By this time, the 'smaller' company has a weaker balance sheet i.e. the shareholders who stayed on are stuck with a dud company and the shareholders who sold would have gained more money in the long run had they stayed and demanded that the company make better use of its excess cash.
Why then do management push for a buyback program? Many reasons. But mostly to line their own pockets.
Fact: There is a strong correlation between the time a company announces a share buyback (share price goes up) and the time the management can exercise their share options (the right to buy shares at a certain price). i.e. option to buy at $5 and the shares are at $7 = quick $2 profit.
Moral of the story: If you want to make a quick buck, grab company annual reports and look at the date share options are due to be exercised. Buy shares months before those dates and watch the money roll in.
Disclaimer: I am not a financial adviser and I don't know your personal financial situation. Therefore, this quick buck strategy may not suit you and in fact, you might lose money! Besides, LJ is not an appropriate forum for financial tips and strategies. I am just doing revision for my exams. :P
Other notes: There are cases where the company is genuinely creating value by buying back shares. The final outcome depends on whether the buyback was financed through debt or equity or a bit of both, whether the company sold underperforming assets or cashcow operations to fund the purchase and what the investor's required rate of return is.
All I'm saying is that when you're at a shareholder meeting and the CEO announces there will be a $1.3 billion share buyback program, you should stand up and ask "How are you financing that?" and watch him tremble...