Stock Buybacks Benefit Shareholders

Carson Cole, November 23, 2015

Apple has been the largest buyer in the U.S. this year, with approximately $30.2 billion purchased so far. This is part of a larger $200 billion commitment to return capital to shareholders by the end of March 2017 and in which they have so far completed $143 billion.

So what is a buyback and why do it? Buybacks are purchases of a company’s own stock, typically in the same way that anyone would buy or sell the stock in the open market. This reduces the number of outstanding shares, so those those still holding shares now own a larger percentage of the company.

Earnings are now spread out over fewer shares, measured by earnings per share, so each shareholder will have a larger claim to the earnings. This is good unless the company could have invested in the business, which is necessary for a company to grow over the long term.

With interest rates at record lows, companies can also borrow money for buybacks, and as long as a company is growing at a rate exceeding the interest cost, it produces a net positive return for shareholders.

Buying back shares also should imply that a company does not believe that investments in its own business–buying new equipment, researching new products, acquiring competitors etc.–would generate lower returns than the existing business.

In the case of Apple, they are faced with having too much cash, and a significant ability to borrow money, so returning capital, through both buybacks and dividends, is their best option and the best option for shareholders. They had nearly $41 billion in cash and liquid securities, and $63 billion in borrowings as of September 27. For the prior twelve months, they generated nearly $81 billion in operating cash flow and spent $11.5 billion in capital expenditures.

In cases where buybacks are not to the benefit of shareholders is when they are done to manage earnings per share upwards, possibly to trigger employee stock options, or to increase management’s stake in the business, possibly giving them greater control, such as with shareholder votes. For shareholders, a company and management that makes such self-serving choices and not in the best interests of all its stakeholders should be be avoided.

The bottom line is as long as a company is growing, has access to capital to amply fund its plans, either through cash or debt, buybacks are a smart choice for companies and shareholders.

If it’s a great company, growing strongly and with a bright future, then why not? As a shareholder, you now own more of the company and more of the earnings.