Pardon Me, But What Is Stock Buy-Back?

I keep hearing this term “stock buy-back”, but I wonder how is this supposed to work? Does the following situation constitute “stock buy-back”? I owned a modest amount of Disney stock. At some point (circa 1996) Disney sent me a letter to up my shares to 100 shares (of common stock) minimum. I took no action being unable to afford it. Years pass, and circa 2010, my Disney stock was cashed out with a check mailed to me. Is this what is meant by “stock buy-back”, and is it legal for Disney to close out my account in this fashion - without my consent?

A stock buy-back is when a company uses cash they have to buy some of its own stock back from shareholders, taking those shares off the market. The result is typically a small increase in the value of the remaining shares, because there are now fewer of them.

No idea what happened to your Disney shares, tho. Were they held in a brokerage?

You held what is called an “odd lot” of shares. Shares are normally traded in full lots of 100 at a time. In the old days (such as the mid-90s when Disney sent the letter), there was a significant extra cost to trading less than a full lot of shares. If you had less than 100 shares, that was called an “odd lot”, and companies hated having them just kind of floating around like that; it was a pain for them to keep track of all the people with odd lots, who are entitled to notices of shareholder meetings, annual reports, ballots for voting their shares, etc. And because of the significantly increased cost of trading an odd lot, such holdings often end up untraded, just getting busted up with time and inheritance into smaller and smaller lots. So the companies used to offer shareholders of odd lots the opportunity to either up the holding to a full lot, or sell back their shares to the company, without incurring the normally high fee for an odd lot trade.

It’s not such a big deal any more, because with computerized trading, trading of odd lots is easy to accomplish. I don’t believe most trading companies charge extra for them any more. And as a result, many companies now don’t bother to try and split their stock to keep prices low enough to foster full lots; after all, paying for 100 shares of Apple is really pricey (to say nothing of Berkshire Hathaway!).

As for what happened in 2010, it’s hard to say. It’s possible that Disney decided to re-purchase the various odd lots of the company. I don’t see that there was a stock split or anything else that might have resulted in the company buying your old shares out rather than issuing new odd lot shares. But there are a lot of possible explanations; if you are really concerned, you should enquire of Disney what happened.

Disney has been buying back shares for years. Typically they’ve then used those shares to acquire other companies like Marvel and the Muppets. Thus they’ve been able to vastly increase the size and profits of the company without issuing new shares.

What happened to you in 2010, I don’t know. It’s possible they required you to either sell your shares back (at the market price) or acquire a round lot. But I don’t they they could require this. It’s possible the letter required you to respond that you wanted the status quo and did not.

Stock buybacks in general are fairly straightforward. It’s a way for a company to disperse its profits to the owners of the company. The company does this by going to the stock exchange and offering the going price for the shares, in small increments, over a period of time. Once the company has repurchased the shares, they are extinguished. The remaining shares are now more valuable than before.

You may wonder why the company does not simply send cash directly to the shareholders. In fact this is often done, but tax considerations and other transactions costs mean that companies often prefer the buyback.

As to the OP’s Disney stock, that’s a puzzler.

Think of it in terms of what stock is. A percentage of the company. Then change those millions of shares to macro numbers and you can see what’s happening. Let’s say that I start a company with 9 of my best friends. We sell widgets and each own 10% of the company or 1 share each. Now the company does really well and makes a buttload of money. Typically, some of that money will stay with the company to make it a better company, say to buy advertising or research new widget making devices or buying a bigger warehouse, etc. The rest is distributed to each of us as our profits (These are what dividends are.) Let’s say that Bob, one of the owners decides that he wants out for whatever reason. Now he could sell his share to ‘rando stranger’ and really everything remains the same, OR maybe the company uses its profits from that year to buy Bob’s share from him. It could then dissolve that share. Now, the remaining 9 friends instead of owning 1/10 of the company own 1/9 of the company, so if the company is still worth the same amount, the value of the percentage of the company that our share represents goes up. Instead of the profits being distributed 10 ways, they will be distributed 9 ways. If we decided to sell the company to Conglom-O for 10 million bucks, the remaining 9 of us would each get 1.1 million instead of 1 million. The drawback is that the company was using money that could have gone to other things to instead pay off Bob. That could be a bad decision. Workers don’t like it because that’s money that could go into say productivity bonuses or higher wages that is instead going to the owners (ie shareholders.)

Yes, companies buy back stock - this means there are fewer total shares on the market. The shares a company buys back don’t necessarily “die”. They could be simply held in a bucket or account, then distributed at a later time. When a company for example gives its employees a bunch of shares (I once got 30 shares of the company I worked for as a bonus when they were doing well) those shares come from the open market, typically, unless the board voted to create more shares. They may be bought for the purpose or be in a collection of shares bought much earlier.

The difference is that shares owned by the issuing company are not in play. They cannot be voted (after all a company cannot be its own master) and they receive no share of the dividends (as mentioned above) hence each outstanding share receives a little more. Very often, shares are bought back as a ploy to raise the value of outstanding shares - something many boards and CEO’s are judged on. It’s common when the administration feels the shares are undervalued - justified as “when people realize the proper value of these shares, we can sell them back on the market again and actually make money”.

As for your Disney shares - I’m surprised they were sold out from under you, unless as mentioned it was a “do nothing and we’ll sell” letter; or the shares were actually help in trust by Disney themselves. I have trouble imagining any broker house actually allowing someone else to come along and order a trade on your behalf. (When I got company hares in an odd lot number, they were actually part of a plan/fund by the company and were held in trust by them. )

Compulsory acquisition /compensation normally only happens when a company is sold.

Another thing that happens is that a company makes a stock acquisition at above-market price (perhaps buying shares from an executive) and is compelled to make the same offer to certain classes of shareholders. Because the offer is above market, they may be required to assume that certain classes of shareholders accept, unless the shareholder specifically rejects the offer.

Could it be that Disney has undergone some kind of corporate restructuring that counts as being sold?

But the company spent cash reserves in the buyback, and this exactly counteracts the decrease in shares on the market.

If the share price goes up, it’s because a buyback is a signal of confidence on the part of the company. It means the company thinks the price will go up further from future events, and that they are stable enough to go without liquid cash in the short term.

As with the buyback, if you send $10 to everyone with a share, that share will then depress in value by $10. In that respect, dividends are a completely neutral operation (of course, taxes and the like do play a part). Lots of companies pay dividends but they’re viewed somewhat negatively because it means the company can’t think of anything better to do with their spare cash than to give it to shareholders. That’s not all bad but it does mean the company is out of its growth phase.

Yes, I don’t know the details of this particular exchange offer, but they’re common. Every publicly traded company has a transfer agent that deals with the day to day operations of shareholders. A company like Disney, which has a very large number of people that own one share due to a Christmas gift, has a particular pain with their shareholder services. As things have gotten more electronic, it’s a pain to send out physical notifications to people who got one share as a gift from an uncle 20 years ago. So, they have every incentive to try to get people who own less than 100 shares off their books.

Buybacks seem to be significantly more efficient for stockholders than dividends, so I wonder why they haven’t pretty much replaced them.

Instead of issuing a 3% dividend buy back 3% of shares. That way the shareholders that want to receive taxable income get it, and those that don’t, don’t.

I’m sure I’m missing something here. What is it?

There’s a finite number of shares, and if you do this for too long you end up causing liquidity problems.

A lot of money is in tax deferred accounts, like IRA/401k and various institutional money that’s just taxed on the total return or not taxed. A big portion of invested $'s are indifferent to tax issues.

But the main thing is signalling. By convention stock buy backs are temporary programs. It doesn’t attract that much negative attention necessarily to announce and complete a buy back program, then not do another, or do a smaller one. Whereas it’s a big deal to cut a dividend, therefore they are only raised with caution. Dividends tend to represent management’s view, in action not words, of long term profitability. Cutting them is often taken very negatively by markets because of that signaling effect, despite rational investors knowing that for a given profit it doesn’t matter.

Besides which some people, not strictly rationally, just want dividends. You can see that at even relatively sophisticated retail investor forums on the internet.

In a world of not only perfect rationality but perfect information and trust, it would be ‘I don’t care’ v ‘I want buy backs’, and buy back would always win. But in the real less than rational world with asymmetric info between managers and shareholders, and rational reasons not to take management statements at face value, dividends persist, though buy backs are more common than they were.

A stock buy back entails more risk for the investor. A dividend is your share of corporate profits. A stock buyback is paying you those profits in company stock by making the percentage you own in the company greater. That’s great if you own stock in a Fava bean importer and the next hipster trend is fava beans, but maybe you would prefer your fava bean profit in cash in case Donald Trump decides that only immigrants eat Fava beans and plants a 10000% tariff on them. The money that you should have gained from the great hipster fava bean lovefest of 2019 could quickly evaporate if all that happened to those profits was a stock buy back. The reality is that most companies offer automatic dividend reinvestment if you are the kind of person that does want your profits in company stock, so dividend reinvestment can give you the best of both worlds. Either buy more or don’t as you see fit.

No there’s no difference in risk. If you get paid a dividend you can choose to reinvest that in more stock or keep it in cash. If there’s a buyback you can choose to just sell some stock equal to what the dividend would have been, or not. Same risk assuming keep the dividend in cash/sell some stock, or reinvest the dividend/don’t sell stock between dividend/buyback case.

And in the best case for dividend tax treatment (in the US) will be only the same as the buy back (sell stock equivalent to dividend capital gains tax would be at a maximum the same as tax on dividend). It’s usually worse.

The reasons for dividends were given just above: to some degree it’s just irrationality, but to some degree it’s a rational response to information asymmetry and agency issues between managers and shareholders.

Completely agree. These are exactly the items that managements and boards consider when establishing dividend/buyback policy, along with a variety of other factors like cash flow forecast, debt/equity ratio, potential other uses for cash/investment capacity, comparison to peer companies, etc. It’s commonly known that buybacks are more efficient and less paternalistic than dividends. After all, you can pay yourself any dividend you want by simply selling shares equivalent to whatever dividend yield you desire, regardless of whether the company is actively repurchasing shares.

Don’t forget that an ordinary investor (especially holding their shares in a tax-efficient account) might prefer dividends to buybacks, because then they can realise a cash benefit from their investment without incurring brokerage fees. If you want to realise profits from a buyback, there will almost invariably be a dealing charge to do so. Many institutional investors will have similar issues. So it’s not totally cut and dried.

I think that if it’s a large shareholder, whether institutional or personal, the concern with selling stock to pay yourself would be moving the market and devaluing the stock you own. Trading costs for instituions are minuscule, like 1.5 cents per share.

But I agree that the costs could be significant for a portion of the general public.

Thanks, all, for the explanations. Clearly, finance is a foreign language to me.