Share Buybacks

Share buybacks are a bad idea.

Suppose that a company has a 5% dividend yield. The price to dividend ratio would be 20. Suppose that the company decides to buyback shares instead of paying a dividend. Unless prices change, the number of shares would still be 95% of their original amount, but the dividend yield would be zero.

Suppose instead that the company decided to buyback shares with one half of the dividend amount. The number of shares would be 97.5% of the original amount, but the dividend amount would be cut in half. Unless the prices change, the dividend yield would be only a fraction higher than 2.5%. It would be 2.564%.

Nothing has been done to increase earnings. The hope is that prices will change disproportionately. But why should they?

One legitimate reason for share buybacks is to position a company for future expansion. Repurchased shares are a piggybank for a stock swap. This can make sense if the shares would normally rise on their own accord.

Most often, share buybacks simply work around the millionaire’s tax on corporate salaries exceeding $500000 annually. [Political accounting.] They are not a reason for shareholders to rejoice.

Have fun.

John Walter Russell
November 24, 2007