Wall Street likes Buybacks
IBMs announcement of a stock buyback plan really lifted wall street today. But why do buybacks rock the street as much as they do, and why do investors love to see it happen?
First and foremost, a buyback means less stock available for purchase. Ownership in a company is increased per share after a buyback. Stock has more value because it represents more of the company. A buyback of $15 Billion in stock by IBM means that the $15B should be theoretically redistributed to the remaining shares. Obviously the market doesn’t follow the math perfectly, but you get the idea.
It can also show financial strength in some companies. Many think it shows that the corporation has no better investment than in itself. A buyback might also mean that the corporation thinks its stock is oversold, thus starts buying back shares on the open market to keep its share price up and show some stability. A buyback can also be done for other reasons, so this might not be true.
Manipulating data
After completing a buyback, the shares are usually cancelled or held as Treasury shares. Treasury shares are as good as cancelled, they have no voting rights, no dividends and do not trade on the open markets. A buyback will reduce the amount of assets, particularly cash, and improve its return on assets figure. It will also lower the amount of outstanding shares and increase the earnings per share figure, stumping analysts at the end of the quarter. By reducing share count by 10%, the earnings per share figure will rise by 10%. This is a quick game some corporations play to increase income statistics.
A stock buyback can also be done to reduce the PE ratio of a company. Less shares means more earnings per share and a better PE ratio.
For a company like IBM, it is likely that the company just wanted to lose some assets. But for smaller companies, buybacks may be done for sheer manipulation of the statistics. A buyback can be both good and back, a bit of due diligence can usually clear that up however.
