This article describes IBM as buying back $10 billion in shares. The article says
Do any of you know why they would do this?
Say company X has 100 shares outstanding and I own a share. That means I own 1% of the company. If the company then buys back 10 shares I now own 1/90 of the company or 1.11% My shares are now more valuable thanks to the company buying back the shares.
Except, of course, that the company had to pay people for the 10 shares, so you now own 1.11% of a slightly poorer company. 
It is also an investment decision, and a signal. They have a pile of cash. Buying back shares indicates that they think (or seem to) that buying their stock will provide higher returns than other uses of the money.
That’s USUALLY the case, and IBM’s buyback seems a bit odd. Somebody on seeking alpha musing on the subject:
Many companies are flush with cash right now, which can also make buybacks attractive.
ETA:
Yes, juicing the earnings per share is meaningless if the number off shares decreases by a corresponding amount, but if somebody misses the fact that there’s fewer shares out there, it looks like “earnings growth”.
Not so. You own 1.11% of a company that has less cash, but it still has the same value. It bought an asset (the shares) with the cash - one would hope an asset worth the same amount (or more) as the cash used to purchase it.
What a buyback means is that the company cannot think of any better way to use its cash to enhance shareholder value. It does not think it can invest the money in expansion for greater gain, for example.
How about a dividend instead?
What happens if a company buys back ALL of its shares? Does it become a real boy?
It’s possible. However, there are different tax treatments. As a shareholder, if the value of my shares goes up because of a buyback, I don’t owe any taxes (yet). If I get a dividend, I have to pay tax immediately.
Buybacks made even more sense in the past when capital gains were taxed at 20% but dividends at your marginal income tax rate. Right now, both are 15% so the tax differential does not apply.
A dividend transfers cash to all of the shareholders, and decreases stock price. A buyback transfers cash only to those shareholders who sell, and has no clear effect on the stock price. (In practice it may have an effect to the extent that shareholders perceive it as a signal or a change in management thinking.)
You either still own 1.00% of the company as originally valued, or you own 1.11% of a poorer company.
If you consider the shares to be still in existence, and still an asset to the company, then the original shareholder still owns only 1.00%. If the shares cease to exist, they are no longer an asset, and then the other shareholders own 1.11% each, but of a less valuable company.
Yes - you are correct. I was getting mixed up with comparing with a dividend, where you end up owning 1% of a poorer company (and the share price goes down to reflect that).
How are the repurchased shares carried on the books? I doubt the money paid for them just vanishes, so it doesn’t seem right to say it is a poorer company.
At one point companies repurchased (or issued) share for stock options, but with the tax problems with them they may not need so many. There are still grants, but seem smaller than in the good old days, since they have immediate value upon vesting, unlike options.
You may like the Investopedia article:
In a sense, the money DOES just vanish, as the company now has fewer assets, offset by also having fewer shares outstanding. See their hypothetical example near the bottom of the article, underneath “improving financial ratios”.
The money doesn’t vanish, but it’s no longer the company’s money. I’m not an accountant, but in a stock buyback they’d have to decrease the shareholder’s equity to balance to decrease in cash.
Correct. If the shares are retained as treasury stock (this allows later resale without jumping through the hoops necessary for a new stock issue), they are carried as “contra equity”. If the shares are retired altogether, then they vanish and the equity associated with them vanishes. Either way, net owners’ equity decreases.
The Register gives the solution to the particular case of IBM.
Link to el Reg article
At that point, the corporation as such would no longer exist. It would have to re-charter under some other law, since it wouldn’t have a legal structure.
Well, I suppose you theoretically could have a corporation which owned all its stock, and thereby existed solely for its own sake.
In many cases, the company honestly believes that its shares are being waaaaay undervalued by the marketplace and are therefor a bargain and is taking advantage of that fact. (Assuming that they’re looking at things in an unbiased manner, any company is probably the ultimate insider in terms of what its future earnings are likely to be.)
Of course, this is also a way to try to convince the marketplace that you, as the ultimate insider, believe that when you actually don’t…
In b-school you’re taught by the finance academics that buybacks and dividends are two means to the same end of giving money back to the shareholders.
A company’s value is the value of its cash and the PV of its expected future earnings. In theory every shareholder has an equal ownership rights to both.
In a buyback:
-Shareholders who sell give up their rights to the PV of future earning for an equal value of the company’s cash.
-Sharholders who sell see their share of the cash balance reduced, but gain rights to the PV of future earnings given up by those shareholders who sold.
Everyone is made whole, it’s just a way for the company to disburse cash and doen’t affect the total value to the shareholders. No one gains or loses. The “value” is accrued when the company creates shareholder value through ongoing operations. Just like when the company gives out a dividend the value of the company goes down, but the shareholders are fine because they’ve received cash equal to the value of their stock price drop.
What isn’t irrelevant is the market reaction to volatile dividends. A one-time buyback is often more palatable than a one-time dividend or changing the dividend.
If the CEO’s personal greed is the true reason for this buyback, should the shareholders at large be upset? Or, does IBM benefit from this buyback?