I have a simple question for you...
If you could buy 5% of a company and have it turn into 10% of
the business -- without investing another dime -- would you do
It's obviously a rhetorical question. Who wouldn't want their
stake in a company to double in size?
Well, it so happens that you can do this. And you don't have to
reinvest dividends or paytaxes on any capital gains.
Let me explain...
Certain companieswill periodically "give away" a portion of
company ownership, free of charge, to their existing shareholders.
They'll even spend billions of their own money to do it.
has been known to do this. The company is on track to "give away"
$2.5 billion worth of ownership by the end of 2012, but recently
said it would begin "giving away" $18.9 billion more as early as
Starbucks (Nasdaq: SBUX)
also likes to have these "giveaways." In the past 11 years, the
company has "given away" $5.1 billion worth of ownership.
But it's not just these two. Every year, companies across the
globe are "giving away" billions of dollars worth of company
ownership. Investors get it tax-free and often watch the share
price rise afterward.
How does this work? Through share buybacks.
When a company buys backshares of its own stock, it makes every
share you own worth a larger percentage of the company.
To keep things simple, imagine you own one share of a company
that has 10shares outstanding . You would own 10% of the company.
Now, let's say the company bought back five of the 10outstanding
shares . You would then own one of five outstanding shares, or 20%
of the company.
Your ownership has doubled, but you don't have to pay taxes on
the increase. And as long as the company's value remains unchanged,
each share of stock is twice as valuable.
Companies with strong buyback programs have consistently beaten
the S&P over the years, especially recently. This is clear when
you look at the
PowerShares Buyback Achievers Fund (
. This fund has tracked the top buyback companies since Dec.
To become included, a company must have repurchased at least 5%
of its outstanding shares in the past year. Top holdings include
Home Depot (
to name a few. As the chart below shows, the buyback fund has
handily beaten the S&P.
The same goes for many individual companies. Take
, for example.
Since 2009, IBM has repurchased more than $40 billion worth of
its own stock. In that time, the company has more than doubled the
The boost these buybacks can give a stock is one reason I like
investing in companies with strong buyback programs.
But there's one other thing you should know about companies that
buy back shares. It's an investing secret that might sound odd, but
it could help you make long-term wealth in themarket . It's a
trickWarren Buffett has used for years.
In his 2011annual report , Buffett praised IBM for its financial
management. That makes sense. After all, even with its huge $217
billionmarket cap , IBM's stock has more than doubled the market in
the past few years.
But Buffett also said something surprising. He talked about how
he hoped IBM's stock would "languish" for a few years. Why on earth
would he want that?
It's because IBM has said it will purchase $50 billion worth of
additional shares through 2015. If the share price stays flat
during that time, or even goes down, the company's $50 billion will
buy back more shares than if the share price soared.
And Buffett knows the more shares bought by IBM, the greater his
stake in the business becomes. Most importantly, this principle
works for all investors. Any shares you own would be more valuable
Risks to Consider:
Keep in mind that share buybacks don't necessarilyguarantee
that the share price will rise. Although they can give investors a
larger piece of the pie, if the pie is shrinking, then the total
value of yourinvestment could decline.
Action to Take -->
But as a general rule, if you invest in companies with strong
buyback programs, then your shares are likely to increase over time
as your stake in the business grows -- even if the company's actual
business doesn't grow a cent.