No. of Recommendations: 14
Buybacks done at fair value do not increase the value of the remaining shares at all in the present. Yet, a smaller share count going forward increases the likelihood that earnings per share (EPS) will, all things being equal, be greater in the future. And, EPS is the metric that, for the majority of companies, investors take as indicative of value, and so, it tends to influence share price.
You might have accounting slip here, in that you are double counting the effect of growing earnings within the fair value of any firm. As the market cap of a firm already accounts for the future earnings, then when a firm purchases the stock of any company at fair value (whether it done by buying its own stock, adding its own company to an investment portfolio, or adding some other other firm to the investment portfolio; it makes no difference) then it has simply exchanged cash for a similar value of something else. The firm hasn't magically become more valuable regarding its future projector of its earnings. I underline the future because the value of a firm is not determined with an assumption that the cash will be indefinitely hoarded, but rather we already assume the cash will be invested in various ways.
Forget about buy-backs and just think of it as purchasing any stock in your own investment portfolio. In fact, a company buying back its shares is economically the same as the same company creating a portfolio with shares of its own company (the share count thus not decreasing). Very few people realise that. But returning to your own portfolio, imagine you have some mixture of cash and stocks. When you purchase some stock, do you consider that your net worth has increased, or you do think your future likely wealth has increased. Of course you don't, because whilst it will have likely increased compared to never buying stock at all in the entire future, prior to the purchase you will have retained the optionality to purchase stock at any time.
- Manlobbi
