In a recent article by David Berman, he discussed about stock buybacks. A company has cash in the bank and rather than investing in the business decides to reduce the number of shares outstanding by buying them back at the market price. If all things are normal, the profits are distributed over few shares which means the earnings per share increases which could increase the share price. In 2017, companies in the S&P 500 spent a total of $519 billion on buybacks according to the S&P Dow Jones Indices.

With everything in Wall Street, the are always two sides – pro reduces the shares outstanding which increases the earnings per share and the stock should rise because the multiple for EPS is low.

The other side is called the contrarian view – in the past the lowest buybacks are in a bear market when stocks are less expensive and more tends to be in bull market when stocks in general are higher priced. Perhaps it is better to sell when companies are buying.

Buybacks are liked because if a company is able to buyback shares, it is in or should be in good financial shape. Buybacks are favored by management because it allows them the flexibility to buy the shares as opposed to increasing a dividend. If they increase the dividend, then it will be permanent or if next year lowering the dividend is not a good thing.

When the lowering of the tax rate by President from 36% to 21% expect more of the 15% to increase buybacks in 2018.

Linking to dividend paying stocks, the first aspect of whether a buyback is good or not is the company profitable? If it is then it has the option to either do buybacks, increase dividends or invest in the company. Ideally it can do all three. Buybacks help drive up stock prices, however if you are investing in a long term whether the stock price goes up a few points should not matter too much. When it jumps above 50% above what you paid then you need to look at options. If you sell, you can diversify into other dividend shares and essentially own the remaining shares at lower cost. Then you do not need to worry if the shares fluctuate but you can worry they have long lasting in the marketplace.

There are more questions than answers, till the next time – to raising questions.