Stock Investing 101

Lately companies have been moving away from giving away large dividends in favor of purchasing large portions of their own companies.  Stock buybacks are where a company buys a significant portion of their own stock.

Pro’s of stock buybacks:

• Stock buybacks increase a companies EPS [Earnings per share] and makes each share of the stock more valuable, so in most cases, the value of a share of the company increases after a buyback is completed. If a company makes 1 billion dollars a year and has 100 million shares out on the market, it’s earnings per share is 10 dollars. If it buys back 10 million shares of its company, it’s EPS is now 11.11 a share, more than a 10 percent increase.
• A company buying back its own stock is a signal that the company thinks its shares are undervalued. Business’s do not make investments unless they think that the investment will generate a profitable return.  If a company that trades at 20 dollars a share decides to buy back a large portion of its shares on the market, the company, which has tons of insight and inside information, likely thinks that its stock is worth between 30-40 dollars a share.

Con’s of stock buybacks:

• Companies use their own cash to buy back its shares.  Instead of making an acquisition of a smaller company or making steps to grow its business, the company is simply buying its own shares. The more cash a company has the better position it is in financially. Also companies normally only buy back its own shares if their growth prospects look weak [they have nothing better to spend its money on].
• Companies could directly give you the money instead of buying its own shares.  I mentioned earlier that dividends are going out of style.  I for one am still a huge fan of getting a large dividend check every 3 months and reinvesting the money back into the stock.  It is tough to beat DRIP Investing over the long haul.

Mature, large companies in lower growth fields such as healthcare and the oil industry are the most apt to buybacks some of its shares. Stock buybacks are here to stay, whether you like them or not! Companies have done much dumber things with their money over time then buy its own shares, trust me!