Market Edge Report: Stock buybacks

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Market Edge Report empowers the self-directed investor . Each report investigates a single market metric in depth. We don't just give you numbers, we show you where to find them yourself, suggest what you might want to watch for, and offer some perspective as to what it all means.

Part One: Why do companies buy back their stock?

When a company you own stock in gives you money in the form of a dividend, the value is easy to understand. It is harder to see the value when that company gives that money not to you, but to the market, in exchange for shares of its own stock. How could any entity grow stronger by consuming itself? Metaphors fail, as stock repurchase plans really aren't like anything .

To understand the value of share buybacks, consider what it means to own stock. Each share is fraction of the company, the numerator being the number of shares you own, and the denominator being the total shares outstanding. Most individual investors don't think of their shares in "percentage" terms, because they buy stock for appreciation, not control. (Wealthy, institutional, and activist investors most certainly do think in percentage-of-ownership terms, as at 51% of a company, a shareholder gains "controlling" interest, but I digress.)

Say you own 600 shares of Disney ( DIS ), a company with 1.72 billion shares outstanding. You own 600/1,720,000,000 of the company, which is 1/3,488,372 or one three-million four-hundred-eighty-eight-thousand three-hundred-seventy-second   of the company. Disney's market cap - the total value of the company -- is $155 billion, and it is worth pointing out that this value should be (and generally is) the same, regardless of how many shares of DIS are outstanding.

If you didn't follow that last sentence, read it again - all real stock analysis proceeds from understanding this.

So what is your hypothetical percentage worth? Well, 1/3,488,372 of $155 billion is $54,069, and we can quickly check to see if that is reasonable by multiplying our number of shares, 600, by the current share-price, which about $90. (That comes to $54,000, so yes, math is working properly.)

Suppose Disney decides to buy back 35 million of its shares. At $90 per share, that would cost the company about $3.15 billion, and it has the cash on hand to cover it. Once Disney has its shares back, they become treasury stock and could, in theory, be sold back to the public someday, but for as long as they remain treasury stock, they effectively don't exist. That means there are now 1,685,000,000 shares of DIS outstanding, so your piece of the $155 billion pie is now 1/3,560,830, or $55,192. See what happened? The buyback raised the value of your stock by $1,123, or $1.87 per share. Correspondingly, DIS stock is now (hypothetically) worth $91.87 per share.

Continue reading page 2 of this article


This article was originally published on MarketIntelligeneCenter.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Earnings , Taxes

Referenced Stocks: DIS

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