Stock Buyback Benefits to Shareholders

One of the most notable examples for stock buyback is Microsoft. It has announced that by the year 2011 it will repurchase $40 billion of its stocks from the open market.

Many reasons can be pointed out as the potential ones underlying Microsoft's buyback. No matter what they are, it should be noted that stock buybacks are for the benefit of shareholders.

One of the reasons that can be pointed out is that fewer stocks in the open market mean a higher value of those that remain on the market. There is no change in the structure of the company, only that the value of the stocks outstanding has increased. 

After the company has repurchased the shares, it has two options. First it can cancel them. Second it can put them in its treasury. Whatever its decision, the stocks are out of use.

The company may justify the stock buyback with the argument that this represents the most efficient investment the company can make at the time it repurchases the stocks. In this way the argument of creating money on behalf of the shareholders is made. Since the stock buyback increases the value of the stocks, managers are awarded with the recognition of creating additional wealth for the shareholders.

However, there are other reasons for the company to call the stocks, which are not so for the good of the shareholders. For instance, the company may want to increase the values of the following:

• Price earnings ratio
• Return on assets
• Earnings per share
• Return on equity and etc.

By implementing a buyback program the company will be able to pump up the values of these ratios.

However, the buyback program will not solve any of the problems the company experiences before the repurchase. They are there to stay unless other strategies are implemented.

A buyback program may be implemented also for the purposes of repurchasing the too many stocks that are available on the market, which has resulted from the overgenerous stock selling. The amount of the outstanding shares is increased by the exercising of stock options. As a result the ratios of the company appear weaker.

Let's return to the case of Microsoft. Since the company has accumulated a huge amount of cash, it had to implement one of the following strategies:

• Make a wealth creating investment
• Return the money to its shareholders (e.g. through stock buyback or dividends)

Final Piece of Advice

The next time your company announces a stock buyback, look carefully at the numbers that the company offers. This is required in order to interpret the reasons for the repurchase and to see whether it is for your benefit or not.

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