Leveraged Buyback

And finance allah shmoop why do companies buy back their

own stock Well sometimes wall street simply gets it wrong

Investors place of value on a company based on whatever

price its stock is trading at and when investors do

get it wrong on the low side cos they're usually

the first to realize the disconnect and they're usually wise

to proactively take advantage of it in buying back their

own stock That's the basic quick and dirty But the

details answer for why companies buy back their own stocks

a bit more complex companies who have excess cash used

to just pay a dividend and when they still had

more cash than they needed for upgrading those smelting plants

and improving their assembly line efficiency and perfecting the quality

of their pooper scoopers while they simply up to their

dividend But then tax laws changed Basically tax rates went

higher Acme hemorrhoid cream supply company makes a billion dollars

in operating profit a year and it pays three hundred

million bucks in taxes to net seven hundred million dollars

in earnings but then pays three hundred million dollars in

dividends back to shareholders but then shareholders pay tax on

that three hundred million well in california for example shareholders

would pay something like one hundred million dollars in taxes

on those three hundred million in dividend distributions so the

company just earned a billion box and four hundred million

of it went back to the government well eventually companies

and individuals got sick of such a heavy tax burden

So instead of paying out taxable dividends companies began using

that excess cash to buy back their own stock Instead

buy backs are not taxed so that entire three hundred

million dollars that might have gone out for dividends had

the company used it all for buybacks would be some

thirty percent more efficient Keep in mind that buying back

stock shrinks the pie of ownership That is if a

company has two hundred fifty million shares outstanding and earned

five hundred million bucks in a year each year for

five years But each year the company bought back ten

million shares than at the end of those five years

The company would have just two hundred million shares out

standing while still earning the same five hundred million bucks

Initially the company was earning two dollars a share about

with fewer shares that two dollars per share grew to

fifty a share So even on flat earnings the company

was able to grow its earnings per share just by

buying back its own stock So yeah all of this

is nice and can work well if the company trades

at a low price to earnings Multiple low means that

the company believes it will be around for the next

fifty years or so It earns a dollar share and

trades for ten dollars a share and has no debt

and is growing revenue steadily it in a five six

seven Eight percent a year and lives in an industry

which this year for some stupid reason is out of

favor with young wall street investors So the stock which

used to trade a twenty five times earnings now trades

at only ten times and with the company believing it'll

still grow earning sizably in the future at ten times

this year's earnings nine times next years and eight times

the following year's earnings the company looks like a bargain

if the's low multiples So let's say a company has

no cash and no debt and will earn a dollars

Share this year in trades for ten bucks a share

Well if it took half of its earnings to buy

back stock and if the stock price stated ten bucks

and the earning stayed flat at a buck a share

well they'd have fought back the entire company in twenty

years In reality with fewer shares and even just flat

earnings i'ii earnings that aren't growing a company's stock price

would almost always go up So in a sense this

is a way for a company to force ah higher

stock price or force wall street to recognize its value

So all of this is great In theory the reality

is that many companies think they're better than they really

are and spend billions buying back their own stock at

twenty bucks a share after it fell from eighty on

ly to see the stock Ten bucks a share two

years later the wall street pros do nothing all day

over even figure out the trends that shaped stock prices

in the future So it's a rare company that can

see that vision more clearly than the droves of professional

investors all around him of course there's a second possibility

Maybe a company just has a sentimental attachment to its 00:03:58.453 --> [endTime] stock and the missing reunited And it feels good