Why does a company buy back shares even though it has made huge profits?

Question

Today BLT has announced a profit rise of 77% but its shares are falling . Why ?
BLT has also set aside 3Bn USD worth shares buy back. What is shares buy back and how does it relate to share holders?

Answer 1

Because it increases the profit per share. That should increase the stock price, which makes shareholders happy. Example -

Guns R Us has 1,000,000 shares. It makes an annual profit of $10 million, so the earnings per share is $10. The stock price is $120, which means that the price earnings ratio = $10 / $120 = 12.

Guns R Us decides to buy back 100,000 shares, so it now has 900,000 shares outstanding. The annual profit is still $10 million but it is spread over a smaller number of shares so the earnings per share rises to $11.11. If nothing else has changed the price earnings ratio should stay at 12. That means the stock price should rise to $11.11 * 12 = $133.32.

Shareholders are happy because they've made a profit of $13.32 per share.

Sometimes it doesn't work like that, but it usually does. Sometimes the market decides that the buy back means the company deserves to trade at a higher price earnings ratio because of the buy back. That is even better news for shareholders because it means the share price goes up even more. If Wall Street decided Guns R Us should trade at a price earnings ratio of 15 after the buyback that means the shareprice would be 15 * $11.11 = $166.65.

Answer 2

Shares often fall when companies have reported big profit increases. I think the reason for this is that rumours go round of "record profits", people buy and push the price up in the hope they'll be even bigger than they actually are, and on the day of the announcement the price corrects back slightly. Look at the price over the previous month and it's probably done very well.

As for buy-backs, I find them really annoying - especially the "compulsory" ones, where they buy, say, 10% of your shares back at a price THEY set. I'm never sure how, legally, they can force you to sell them something AND set the price. Anyway, if this is the case with BLT, you should get a letter from them (or your broker if they hold the shares in a nominee account for you) telling you about how it will be paid.

The theory is that they are a way of "returning value" to the shareholders - giving them cash as a capital gain, which for many people is more tax-efficient than giving an extra-big dividend (which would attract income tax instead).

In practice, it means that although I might have decided to invest £2000 in a company, I now find I've only got £1800 invested with them, and £200 in cash that I now have to think about investing in some other way - or if I want to buy another £200 of shares in that company, I have to pay a dealing fee.

What's more, "corporate actions" like this, or restructuring or takeovers, just make tracking what money you've actually made from a stock a complete nightmare. Personally, I wish they'd just get on with doing their core business.

Answer 3

Buying back the shares is a way of giving back money to the shareholders. Regarding drop in shares despite profit rise, it is possible that there's a sudden increase in shareholders selling their shares in order to take advantage of the high price of the share. The increase will cause the share price to fall. Also, it is possible that shareholders are not convinced that the profit rise is sustainable - it could be a blip that's not likely to recurr in future.

Answer 4

Companies buy back shares for many reasons. Here's how I think it plays out. If they have cash to invest, why not buy an undervalued company that is reporting great earnings. They know the business, their business, and its prospects. If there isn't another comapny to buy, why not invest in their own company? Later, when the shares rise, they can sell them or give out options against them.

Answer 5

Well issuing shares is a form of borrowing. If you don't need to borrow it anymore you pay it back. (Buy Back shares)

Then in future years you don't have to pay as much interest (in the form of dividends) to your shareholders and that retains more profit within the company.

Shares can fall in value if the market had expected better results from them, or there are worrying trends identified (fall in gross margin) not noticable from the headline profit figure.

Answer 6

generally, the stock market is completely random. no matter how a company performs, the stock may rise or it may fall on a given date. generally, in this situation, people who had the shares are trying to cash in by selling their shares, thus driving the price down.

regarding the 2nd question, buying back shares is the opposite of splitting shares. the company tried to raise money by issuing more shares, and now is "repaying" that money by buying the shares back.

Answer 7

Buying shares back can make investors happy, as the ownership of the company is now spread over fewer shares.