No. of Recommendations: 4
Mungofitch:
How much will you bid for this bag with nothing but a hundred 100-euro notes in it?
The short answer is: since I have no idea when I'm going to be able to open that bag of money since it is in the treasury of a company whos stock I own, its going to be a whole lot less than €10,000 that I would pay for it. Unless I conclude that that bag of cash is busily adding at least €10,000 to the value of the company holding it, in which case I will carry it on my calculation of IV of the company at face value.
Of course, in the discussion, the cash used for the buyback was described as "excess" cash. I would submit that for cash to be considered "excess" it must be adding less than its face value to the IV of the company in question. So lets say we consider the company with the €10,000 in its treasury and conclude it is worth IV10 = €19,000, but the company with only €8,000 in its treasury is worth IV8 = €18,000. And lets say we start with 19000 shares outstanding. Then the IV of each share when start is €1. Lets say we are able to buy back 2000 of those shares at €1 each. Then the IV of the company when we are done is IV8 = €18,000, but there are only 17,000 shares now outstanding. So, paradoxically, we have bought shares back at price=IV, and in the process we have increased the IV of the remaining shares by 1/17th of a €, or ~6%.
So interestingly, we could have done the buyback at a price 6% above IV, €1.06 each, and when we were done, the IV of the remaining shares would be the same €1/share it was when we started the buyback. OK well even though that is a neutral deal it feels like a bad deal, so lets say we could have done the buyback at €1.03 per share and wound up with the remaining outstanding shares being worth €1.03 each. So we would have actually increased IV by 3% buy buying back shares at a 3% premium to IV.
The essential thing is that the buyback is done with cash which, if held in lieu of the buyback, is adding less than its face value to the IV of the company. That is, the company may be making a little bit extra by having €10,000 in cash, but IRR of that bag of cash to the company is lower than the interest rate that is used in valuing the company, which is essentially the hurdle rate of the company. If the cash was not "excess", but "essential", then the company would have its IV reduced by more than €10,000 if that cash were gone.
When you say a company needs to keep a certain amount of cash on hand to do its business, you are saying that, on the margin, the last €1 in that account is earning the Hurdle rate, also meaning it is earning the rate the company anyway is using in determining its own DCF value. When you are saying a company is trading at its IV, you are saying it is trading at its DCF value, so you are saying you will earn the discount rate you use in your DCF valuations on your stock purchase.
And we also see why between two alternatives:
1) The company uses €2,000 of its cash to buy 2,000 shares of its own stock instead of you buying them
2) You use €2,000 of your cash to buy 2,000 shares the company's stock instead of the company buying them back
When the company has excess cash, and can buy shares at IV with that excess cash, it is increasing its ROE.
When, instead, you buy those 2,000 shares, you are buying a company with a lower ROE than if the company bought them back.
And this is also why you might want to buy 2,000 shares for €2,000 of the company that is doing the buybacks, but not want to buy those shares of the company that is NOT doing those buybacks. Two different companies, two different DCF valuations, two different IVs/share.
R:)
And here is what ChatGPT5.0 has to say about my post above:
What you’ve laid out is essentially a worked-through example of why the source of the cash matters as much as the price paid in a buyback.
You’re pointing out a subtle but important fact that many investors miss:
If the company’s cash is essential (earning the hurdle rate in its operations), removing it reduces intrinsic value by at least its face value. Buybacks with that cash won’t improve IV/share unless the repurchase price is below IV/share.
If the company’s cash is excess (earning less than the hurdle rate), holding it is actually a drag on IV/share. Using it to buy back stock at IV/share can still raise IV/share — and can even be done at a slight premium to IV/share without hurting existing shareholders.
Restating your example
Before buyback:
Cash = €10,000
IV (company) = €19,000
Shares = 19,000 → IV/share = €1.000
Buyback:
Spend €2,000 cash (excess) to buy 2,000 shares at €1.00.
After buyback:
Cash = €8,000, IV = €18,000, Shares = 17,000
IV/share = €1.0588 → +5.9% boost despite paying exactly IV/share.
Why that works
When you value the starting company at €19,000, you were already discounting the value of that excess €2,000 — it wasn’t contributing €2,000 to IV because it was earning less than the discount rate.
By converting the excess cash into shares at IV/share, you’re swapping a low-return asset for one that earns the company’s hurdle rate.
The “premium tolerance”
Your math shows that:
Break-even premium: ~6% above IV/share (€1.06 in your example).
Profitable premium: Anything less than that, as long as the cash is genuinely excess.
This is the mirror image of the “buybacks destroy value if done above IV/share” rule — that rule assumes essential cash or funded debt, not excess cash.
Implication for your last point
If you have two otherwise similar companies:
One is doing buybacks with excess cash at IV/share (or modest premium).
The other is hoarding that excess cash or deploying it at sub-hurdle rates.
The first one ends up with a higher IV/share and higher ROE going forward.
Buying the same number of shares yourself in the second company doesn’t have the same effect — your capital doesn’t replace low-return assets with high-return ones inside the company; you’re just joining the existing owners in holding them.
