When you receive extra cash you have a number of choices – pay down debt, buy something new – add to the house or vehicle, purchase more stock. A company has similar choices and many companies are flush with cash – give extra money to shareholders (special dividend), give money to workers, buy other companies, purchase their own stock (stock buybacks).
In an article by Noel Randewich of Reuters, S&P companies purchased $880 billion in stock last year, up from $520 billion in 2020. In 2022, Goldman Sachs expects the number to be over $1 billion.
When a company purchases shares, the number of shares outstanding falls which has an effect on the P/E ratio or price to earnings per share. The lowering of the number of shares has an affect on the earnings per share which means the Earnings per share will increase and the P/E ratio will fall. The attraction of possible value helps increase the price of the shares as investors bid up the stock to where the ratio was before the company bought the shares. For example if the normal P/E ratio is 20 and the company buys stock, the ratio falls to 16. Investors will tend to bid up the stock to 20 P/E which translates into higher stock price.
EPFR Informa Financial Intelligence analyst Winston Chua who tracks new buyback announcements, said companies are aggressively repurchasing their shares. New buybacks in March reached $74 billion compared to $54 billion in March 2021.
Linking to dividend paying stocks, there are many methods to benefit when a company is profitable, dividends and increasing dividends is one way, reliable stock buybacks allows for a total return to increase over the years. There are many options when a company is profitable, owning shares is a relatively low risk as long as the company is profitable.
There are more questions than answers, till the next time – to raising questions.