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“Today Shapes Tomorrow

 Published Every Monday    Volume  63 Special Edition May 12, 2008
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Professor's Corner

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What does buying back of shares mean?   

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When companies buy back their own shares in the market, it is called shares buy back.  Companies do it for several reasons: when they have excess cash, or when they think that their stock is cheap.  In case of IBM, it plans to buy $15 billion worth of IBM shares.  When the company buys its own share it reduces the number of shares on the market.  It also sends the message to the investors that the company is expected to do well in the future and the company’s stock price is lower than what it should be.  In other words, the company stock is under-valued.  The reduced number of shares and the positive outlook of the company usually raise its share price.   

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For example, suppose ABC company currently has 10 million shares on the market and its shares are trading at $5 per share.  The ABC is worth $50 million (10 million shares X $5 per share).  In other words ABC’s market value is $50 million.  

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If ABC decides to buy back $20 million worth of shares, then at $5 per share price it will buy back four million shares ($20 million divided by $5 per share).  Now there are only 6 million (10 million - 4 million) ABC shares left on the market.  Let us say ABC is still worth $50 million, then, the stock price has to be $8.3 per share ($50 million divided by 6 million shares).  ABC shareholders see the benefit of $3.3 per share ($8.3 - $5). 

Now let us take the case of IBM.  It has 1.4 billion shares on the market, it announced $15 billion worth buy back, and at the time of buy-back announcement, the stock was at $107 per share.  Let us first calculate the market value of IBM.  It is equal to $150 billion (1.4 billion stocks on the market x stock price of $107 per share).

Now calculate the number of buy back. At the current price, IBM can buy back 140 million shares ($15 billion to buy back divided by $107 per share = 140 million shares it can buy back).  We have made a very simple assumption, that IBM can buy its shares at the current price.  This assumption may not hold true in real life.  

Now calculate the total shares left after the buy back. You can see that now IBM has 1.26 billion shares remaining in the market (1.4 billion that were in the market before buy-back - 140 million bought back = 1.26 billion shares left on the market).  Therefore, the new IBM stock price should be $119 per share (Market value of $150 billion divided by 1.26 billion shares left on the market = $119 per share).  Again, we made a simple assumption that the market value of IBM remains the same after the buy-back.

You will note that the calculated stock price after the buy-back may not necessarily match the actual stock price on the stock market.  Why is that?  For it we need to understand things like, is the share buy back the best use of excess cash by the company?  We will discuss it in the coming issues. 

What does shares buying back means?

Why do companies do shares buy back?

How did IBM do it?


Learn more about...

What is Credit History?  Why is it important to have a good credit history? Volume 12.    

What is Economy, Business, Workers, Goods,  Services,  Stock, DOW, S&P500, and NASDAQ in Volume 16. 

Does it pay to study hard? Volume 17.    

What is Currency and Foreign Currency Exchange rate? Volume 14What is stronger or weaker currency? Volume 20. What does the dollar slide mean? Volume 32.

How does money grow in a bank? Volume 21. 

What is Fed Funds rate and Discount rate? Volume 22

What does the interest rate cut mean for you? Volume 23. 

How to read stock information? Volume 25. 

What is "Black Monday"...Crash of 87"? Volume 31.

Who are CEO, CFO, Shareholders, and the Board of Directors? What is SOX? Volume 33

What does "$4.95 + Tax" means?  Volume 47.

What is a Recession?  What is a Depression? Volume 48.

What is Mergers & Acquisition (M&A)?  What is a Merger?  Volume 49.

 

 

 

 

 

 

 

 

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