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Share Buybacks Distort a Firm’s Results and Reduce Funds Available to Invest

Share Buybacks or share repurchases can distort a firm’s results and delude the public. These events hike earnings per share (EPS) without growth in the firm’s basic value. The baseless boost in EPS could lift a chief executive officer’s (CEO) bonus. So, is a share repurchase plan the best use of a company’s funds? Who enjoys buybacks except the CEO? Let’s examine buybacks and then look at Apple’s repurchase activities over the past eight years.

Share Buybacks

Share buybacks, sometimes called stock buybacks or share repurchase plans, happen when a firm buys its shares on the stock market or elsewhere and retires them. This act reduces shares outstanding and hikes earnings per share. Here is a share repurchase example:

Impact of Company ‘X’ Repurchasing 100,000 of its 1 million Outstanding Shares

Before Buyback After Buyback Comments 
Shares outstanding 1 million 900,000 Purchased 100,000 shares at market price and voided them
Earnings $1 million $1 million No change in underlying business 
Share price $10/share $11/share Assume share price rises because of demand for 100,000 shares (10%) repurchased
Earnings per share (EPS) ($1 million/1 million) $1/share

($1 million/900K)

$1.11/share

Assume no earnings increase
Price to earnings ratio (PE) (10/1) 

10

(11/1.11)

9.9

If the share price remained $10/share, the PE ratio would be 11

How Does a Firm Buyback its Shares

Firms buyback their shares in three ways: 

  1. Buying their shares on the open market, like everybody does, is the most common
  2. A tender offer is less popular. It states the number of shares the firm wants to buy, the price range, and expiry offer date
  3. A private buyback is the least common. The firm negotiates privately and directly with a large individual shareholder.

Why Buyback Shares

Firms buyback shares with excess cash on hand and sometimes with loans. Why does a company buyback its shares? Why not invest funds to grow or modernize its business? These are reasons firms present to support their actions:

  1. Use excess cash: Where the company has excess cash and no investments available to generate returns higher than the share buyback.
  2. Undervalued shares: In theory the additional demand for shares will cause the share price to rise. Existing shareholders might enjoy a sustained price rise if they hold their shares. If they sell now at the higher price they could get an immediate benefit. But shareholders who sell might incur capital gains taxes.
  3. Increase returns to shareholders: Because buybacks under normal situations will increase the share price, firms believe this is a good return for shareholders. But this reasoning doesn’t benefit shareholders who keep their shares. As with the previous reason, real benefits come from a sustained price increase.
  4. Increase earnings per share (EPS): As the above table shows, a buyback increases earnings per share with no lift in the basic firm’s value. Because the number of shares reduces, like EPS, returns on equity (ROE) will rise, too.

Apple’s Share Repurchase Plan 2012-2020

Apple initiated a share repurchase plan in 2012 to buy $45 billion of it shares on the open market over three years. Since then Apple implemented several repurchase plans and by its first quarter 2020 (its year-end is September), Apple spent a whopping $326 billion buying back its shares! During the same period it paid $92 billion in dividends to shareholders. Apple bought its shares on the open market and by private negotiations.

To understand the context of Apple’s spending on its repurchase plan, let’s review its 10-K reports. We will look at capital expenses, research and development, cash on hand, and how it funded the over $400 billion returned to shareholders.



This post first appeared on Authentic Stewardship, please read the originial post: here

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Share Buybacks Distort a Firm’s Results and Reduce Funds Available to Invest

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