> In reality, executives and directors could very well be authorizing stock buy-backs to keep share prices up so their stock options remain in-the-money for as long as possible. If that's the case, the buybacks are meant more for the benefit of executives and directors than for the benefit of the business or its shareholders.
This plan shouldn't work because buybacks shouldn't cause stocks to rise unless the market thinks they're a good idea. For example, if a company with 1 million shares is worth $90 million and has $10 million of cash on top of that, then each share will be worth $100. If it uses that cash to buy shares it will be able to get 100 thousand of them, so it will become a $90 million company with 900 thousand shares. Each share is still worth $100.
It works fine in the short term. It even makes the company more attractive to people who think it is a bad deal - maybe I expect them to go bust in 12 months, but there is an opportunity right now for me to buy shares off Trader A and sell them to a company for a slight markup, leaching money out of a failing concern. I've actually bought government bonds using very similar logic. I can't say if my logic on that specific trade was right, but as long as traders expect buybacks in the near future the price will be artificially elevated.
Essentially, for a shortish time-frame (don't know how long) stocks trade as tokens giving access to a cash flow instead of a measure of the intrinsic value of the company.
The issue is that the price will drop immediately on the prospect of further share buybacks ending. The shareholders who didn't sell are left holding the bag - a company with less cash, more debt and likely a wealthy executive bowing out while the going is good. As soon as something goes publicly wrong that suggests the end of buybacks (maybe a corporate debt crisis of some sort) the stock prices will probably drop further than usual because the buybacks end.
That’s only true as long as the buybacks are done using a cash pile. There are a lot of companies that, instead of trying to grow, give dividends to their investors (think utility companies). Their stock prices tend to be pretty stable, since their inherent worths don’t change much. Suppose there is a 100 million dollar power company that instead of giving dividends of 1% per year, they instead bought back stock with that money. We would expect the stock valuation to go up by about 1%, since it’s now 99% of the stocks holding 100% of the 100 million dollar business.
Right. Buybacks don't raise the shareprice relative to doing nothing, but they do raise the shareprice relative to paying dividends. Maybe it would be better to describe this as "dividends lower the share price".
> We would expect the stock valuation to go up by about 1%
Yes, but not overnight. It will take one year or one quarter or whatever would by the period required for the price to recover if it had distributed the 1% dividend. (You said an annual dividend of 1% but that seems too low for a stable business!)
So the part that this doesn't cover is any sort of earnings multiple/discount. For simplicity assume the $10M was earnings over the last year. Your EPS is $10. After your buyback, assuming all things equal, your same $10M now makes your EPS $11.11.
The point there is the mechanics of buybacks make more sense when you think of how they behave marginally, and what it says about how the company's future earnings are being discounted.
This plan shouldn't work because buybacks shouldn't cause stocks to rise unless the market thinks they're a good idea. For example, if a company with 1 million shares is worth $90 million and has $10 million of cash on top of that, then each share will be worth $100. If it uses that cash to buy shares it will be able to get 100 thousand of them, so it will become a $90 million company with 900 thousand shares. Each share is still worth $100.