Lesson 3 of 8
When a buyback creates value
A buyback helps the shareholders who stay only when the price paid is below what the business is worth. Above that price it moves value the other way.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A buyback only helps the shareholders who stay when the company pays less than the stock is worth.
- Paying more than the stock is worth moves value from the shareholders who stay to the ones who sell.
- A count of shares bought back means little until it is set against the shares issued to employees in the same years.
A share buyback is the company using its own cash to buy its own stock. Whether that helps you depends first on the price paid against what the business is worth, which is the same test you would apply to buying anything else.
Value per remaining share, two prices paid
- Buy 10 shares at 8$10.22
- Buy 10 shares at 15$9.44
Value per share before the buyback: $10.00
The arithmetic is not opinion
Buy shares below their per-share value and the remaining owners hold a bigger slice of a company that is worth the same in total, minus only the cash spent. Buy them above that value and the company has overpaid, and the remaining owners absorb the overpayment. There is no other outcome; the direction follows from the price alone.
Buffett's own test
Buffett's 2018 letter to Berkshire shareholders set out the same condition: repurchases benefit continuing shareholders only when the company buys at a discount to its own estimate of intrinsic value, and buying above that value destroys value rather than creating it. The same letter applied the test to companies Berkshire only owns shares in: when an investee Buffett thinks is underpriced repurchases stock, Berkshire's stake grows without it buying a share. American Express took Berkshire from 12.6 to 17.9 percent over eight years that way. The 2019 letter boiled Berkshire's own rule down to two conditions: the stock sells for less than it is worth, and the company is left with ample cash.
Net the shares issued against the shares bought back
A company can announce a large buyback and still increase its share count in the same year, because employees were issued more new shares than the buyback removed. Stock-based pay is a real cost under ASC 718, Compensation, Stock Compensation, and the shares it creates dilute existing owners exactly as new shares sold for cash would. The number that describes what shareholders actually received is the net change in shares outstanding, not the buyback total on its own. Faber's Shareholder Yield makes the same correction: his net buyback yield is repurchases minus shares issued, and his shareholder yield adds dividends and net debt paydown to it.
What a buyback cannot fix
A buyback returns cash. It does not improve a weak business, and a company paying an inflated price for its own stock while the underlying business deteriorates has made two mistakes rather than one. The average price paid is in the repurchase table, Item 5 of the 10-K and Part II, Item 2 of the 10-Q, month by month, so it can be set against where the stock traded.
Check yourself
A company worth $10 a share buys back stock at $8 a share. What happens to the value per remaining share?
- It rises
- It falls
- It stays exactly the same
Show the answer
Answer: A.
Buying below the per-share value leaves the remaining owners with a bigger share of a company worth the same in total, minus the cash spent. The remaining value per share rises.What does Buffett's 2018 letter set as the condition for a buyback to benefit continuing shareholders?
- That the company has no debt
- That the price paid is below the company's own estimate of intrinsic value
- That the buyback is announced publicly in advance
Show the answer
Answer: B.
The letter ties the benefit to the price paid against the estimate of value. Buying above that value works against the shareholders who stay.A company buys back 5 percent of its shares and issues 6 percent of its shares to employees in the same year. What happened to the share count?
- It fell by 1 percent
- It stayed the same, since the two offset
- It rose by about 1 percent
Show the answer
Answer: C.
The buyback removes 5 percent and the stock pay adds 6 percent, for a net increase. The buyback headline alone would have suggested the opposite.Sources
- Berkshire Hathaway shareholder letter, 2018, on repurchases at a discount to intrinsic value benefiting continuing shareholders, and on the American Express example.
- Berkshire Hathaway shareholder letter, 2019, on buying back only below value and only with ample cash left, and on investee repurchases enlarging Berkshire's share of future earnings.
- Faber, Shareholder Yield, 2013, on net buyback yield, and shareholder yield as dividends, net buybacks and net debt paydown together.
- ASC 718, Compensation, Stock Compensation.
What this leaves out
- The bar chart and the worked example use round invented numbers so the arithmetic can be checked by hand.
- Whether a company's own estimate of value is close to right is a separate question this lesson does not answer.
- A buyback funded by new borrowing carries the cost and risk of that borrowing, which this lesson's arithmetic leaves out.
- Nothing here is advice about any security.