Stock purchasing question (from company's standpoint)

[Angrymarshmello]

Question for you stock guys out there: when a company buys back their own stock from the public, they effectively raise their stock price because there are less shares outstanding, therefore increasing the value of the remaining shares, right?

Well what happens if they buy back I guess "too many" stocks? IE, pretend like they had about 5 million shares priced at $30 per share. If a company were to buy back enough shares that only say, 100,000 or 500,000 shares remain outstanding, would that actually hurt the company's stock price? And why? I'm thinking it would because investors would see that they're buying back a lot of shares...indicating a problem within the company. Reason I ask is because I'm about halfway through a Capstone simulation.....didn't know how much we could really buy back before it nipped us in the bud.

 

[Angrymarshmello]

bump, anyone?

 

[Steve819]

When a company buys back their own shares - they raise their EPS (earnings per share), not their stock price. Earnings per share is computed by taking the company's profits, and dividing by the number of outstanding shares. Since the outstanding share count would be decreasing, the EPS would increase. The stock price would remain unaffected. However, since their would now be a lower multiple associated with the stock price (ie. P/E ratio), the stock price may rise to its previous multiple.

Generally, a stock buyback is seen as positive as it indicates that management perceives that the company's shares are undervalued. Historically, this has been the case - as management buybacks have increased shareholder value, and the stock has performed better than companies with no buyback plan in place. Recently however, many companies have been instituting buyback plans regardless of company valuation, and in the process have damaged shareholder value by buying back overpriced shares, and having the stock price drop afterwards, and wasting the resources the company has already spent.

If a company bought back the vast majority of the shares outstanding like in your example - it would be a highly unusual situation. It would be a rare event. Management might be preparing to take the company private, or protecting against a hostile takeover. It would be difficult to tell how investors would react unless we had more information about why the large buyback was being conducted - management is required to file a SEC document stating reasons for the buyback, and that might provide additional information. It might or might not hurt the company's stock price, however it would greatly decrease the float (available stock for public) and increase the validity of the stock which could cause problems for the company.

Generally a standard buyback plan would be a few million shares - rarely more than 5-10% of the company unless the company has a small market capitalization.

Steve

 

[DaveSimmons]

A mildly interesting question, maybe one to sign up at fool.com and ask in the forums.

> ...indicating a problem within the company

In general a company in trouble doesn't have the spare cash to buy back their own stock, in that situation they try the often-futile reverse stock split.

In my limited experience (I read the business section but all of my stock money is in mutual funds) it's only been cash-rich companies that buy back shares, for upcoming grants to employees and/or to burn off cash when they can't come up with worthwhile mergers or acquisitions and don't want to increase their dividend.

If you do get a better answer at fool, please post it in this thread.

edit: or better than Steve819's already-good answer

 

[Angrymarshmello]

Hey Dave and Steve - thanks, I'm pretty content with Steve's answer. The reason I asked was b/c we're doing a business simulation now - we have about 2 million shares valued at around $56 each - market cap of about $110 million, EPS a little better than $7. Our grade is based off stock price alone (we have the best market share/profits/revenue anyway), so we were thinking about buying back a whole ton of shares the last round to "artificially" jack up our stock price to make sure we have a comfortable margin. (We repurchased $1 million last round and that helped quite a bit, we plan on repurchasing 1 million per round to help drive up EPS and hopefully our stock price too) I was just curious because I think this might be a strategy other teams in our simulation might use, so we don't want to be screwed the last round because we didn't implement that strategy, despite having the most and best consistent performance throughout the simulation so far.