"Stock Buybacks Raise Share Prices Without Paying Dividends"
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Another way that company managements have increased shareholder value -- that is, raised up the market price of the stock -- is through share buybacks.
Stock Buybacks Force Up Stock Value Without Creating New Real Value
Let's say that The Wonderful Acme Company decides to do a stock buyback.
The current market price is $50. They're 100,000 shares outstanding (remember that all 1000 owners own 100 shares each).
On the balance sheet, The Wonderful Acme Company has net assets of $1.000.000. Therefore, each share of The Wonderful Acme Company's stock owns $10 worth of net assets of the company
The Wonderful Acme Company takes the $60,000 it could have sent out to stock holders in the form of dividend checks, and instead sends all 1000 owners a letter offering to buy back your shares for a price comfortably over the current market value of $50 - let's say, they're offering $60.
Well, obviously some people will them up on this offer. Let's say it's 10, to keep the numbers easy.
So the Board of Directors of The Wonderful Acme Company sends those 10 people $6000 each.
There goes the full $60,000 The Wonderful Acme Company doesn't need to keep its operations going.
But Fewer Shares Remain in the Secondary Stock Market
You are not one of the 10 people willing to sell your shares of stock, so you get no money in your pocket from this process
But at the end of it, now only 990 people own shares in The Wonderful Acme Company's stock.
Its net balance sheet assets are still $1,000,000 (that doesn't change), and so now, instead of owning 1/1000 of that total, or $1000 worth -- you own 1/990 of that total or $1010.10.
What's more, your share of next year's profits also increases.
So Market Value of Remaining Shares of Stock Must Go Up - But Total Market Capitalization of the Company Remains Constant
In theory it should go up to about $52. It could be more or less depending on the market.
But the truth is that your overall share of ownership in the company has increased.
The Wonderful Acme Company upper management naturally thinks very highly of itself and its ability to make money from selling widgets now and far into the future.
If they're right about how wonderful they are, this process may eventually increase the market value of your portfolio over time.
Share Price Appreciation Causes a Form of Hypnosis
Most people are so hypnotized by the increase in paper value of their portfolio from stock buy backs that they don't think about how nice it'd be to have extra money in their pockets
In real life, many companies have done share buybacks in the past 20 or more years.
They do tend to raise the market value of the shares of stock remaining in the market -- that's simple math.
But Share Buybacks Don't Put Money Into Your Pocket
Is company upper management always doing the best they can just for the sake of the company and its shareholders? Err, no -- sometimes they focus on raising market value because of their own employee stock options.
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