Wait, Are Company's Buying Their Own Shares?

Ever since the tax “reform” bill passed at the end of 2017, share buybacks have bubbled up in public discourse: “Corporations are not investing their tax savings in plant and equipment, but simply buying back their own stock.”

For those who, to their credit, and likely increased happiness, don’t focus on the machinations of corporate America, here’s why buybacks matter. First, understand most stock prices are based on what a company earns per share. Per share earnings are everything the company earns divided by all its shares outstanding. 

Next, it’s probably not too great a leap to see the higher the earnings per share (EPS) the higher the stock price. So, when a company buys its own shares, what is it doing? It’s decreasing the number of shares used to calculate the earnings per share figure, which has the arithmetically certain impact of increasing EPS figures. As this figure rises, so too should the stock price, and it generally does, but not in lock step.

Share buybacks are hotly debated. Corporations say buybacks can be better than paying dividends, because dividends get taxed. Further, rising stock prices help pension and mutual funds which benefit working men and women. Neo-capitalists say buybacks are simply financial engineering, that distributing wealth requires real investment and that millions of American don’t own mutual funds.

There is no right answer on this one, which means this debate will never end, but now you can pick which side you are on.  

Read more about share buybacks at MarketWatch.

David R. Evanson is a financial journalist in Philadelphia.