In a buyback, a company spends extra money it has to buy its own shares from the share markets.
Then, these shares are destroyed.
Why?
When the shares are destroyed, remember, nothing has actually changed.
The company’s earnings are the same. The management is the same. Everything is the same.
The only thing that has changed is the total number of shares: it has reduced.
Because of this destruction of shares, the percentage holding of each shareholder goes up.
There are 20 apples. You own 2 apples. So you own 10% of all apples.
Suddenly, 10 apples are destroyed. 10 are left. You still own 2 apples. So now, the percentage has gone up. You own 20% of all apples.
Same thing.
A share’s price is linked to its earnings.
So if the earnings remain the same but the number of shares reduces, the earnings per share has gone up.
So the share’s price goes up.
This can be a bit confusing. Please read it again if not clear.
Companies often do buybacks as a means of giving investors money – they either give dividends or do buybacks.
Do remember, it isn’t just shareholders who have shares. Companies’ top executives (CEO, VP, etc) are also paid in shares along with cash.
So they benefit when the share price goes up – just like shareholders.
This is mainly why some people look down upon buybacks: there are executives who have done buybacks
so their compensation would go up.
