Share buybacks
The company buys its own shares and cancels them. Your slice of the business grows without you buying anything.
The mechanics
The company uses its own cash to buy its own shares on the market and then cancels them. The number of shares outstanding falls.
If the company earns 100 million and has 100 million shares, earnings per share is €1. Buy and cancel ten million shares, and the same profit gives €1.11 per share.
You received nothing in hand, but your slice of ownership grew. It is a silent dividend, paid in ownership instead of cash.
Why they are sometimes preferred over dividends
In many jurisdictions dividends are taxed when they are paid, while the gain from a buyback shows up as a higher price and is taxed only when you sell. You choose the timing.
Buybacks are also flexible: a company can stop them without signalling a crisis. Cutting a dividend, by contrast, is always read as bad news.
That flexibility has a price: buybacks often stop exactly when the stock is cheap, because the economy is tough and the cash is needed elsewhere.
When they destroy value
A buyback only creates value if the shares are bought below their true worth. If the company buys at expensive prices, it has spent cash to get back less than it paid.
In practice, many companies buy the most when prices are high and cash is plentiful — in other words, at the worst possible moment.
Also check whether the share count is actually falling. Buybacks often just cover the new shares handed to executives as compensation, and the net count doesn't move at all.
Key terms in this lesson
- Buyback
- A company buying its own shares, which are then cancelled.
- Shares outstanding
- The total number of shares that exist and are held by investors.
- Dilution
- The shrinking of your slice when the company issues new shares.
Quick check
A company announces a large buyback, but the number of shares outstanding doesn't fall. Why?
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