Impact of Share Buyback
How do share repurchases impact ROE?
I've tried researching this topic and there isn't anything concrete on the subject. Intuitively, one would assume that ROE increases, through capital appreciation.
However, given that the general formula for ROE is net income/shareholders equity. How is shareholder's equity impacted? Wouldn't a share repurchase simply net out the impact on shareholder's equity, i.e. total number of shares decrease but value of each share increases?
I'm confused with your question. But I think it's the fact that equity is BOOK VALUE that is stemming your question.
ROE = Net Income/Equity - so if ROE is 250,000/1,000,000 = 25% and then you use $250,000 to buy back shares, your equity decreases by the cash used to buy back shares. So your new equity is 750,000 and your new ROE is 250,000/750,000 = 33%.
Your BV of equity is not impacted by market price, so the increase in market price not reflected at all in equation.
I think my question was a little unclear in terms of perspective. I am trying to look at this from the firms perspective. Are you sure the book value would decrease by the nominal cash used? Wouldn't it be by the par value associated with a single share? For example, if my share par value was $100 but the stock was trading at $1000, i would only be able to purchase 250 shares. This would decrease the book value by only 250*100=$2500. Right?
for share repo, we typically look into how it affects the EPS forward 1 year, 2 years, etc... so in that case, the effect of foregone interest on cash has to be taken into account, affecting your net income line.
Also, we are assuming here that we are just using cash on B/S to buyback shares, sometimes company raise debt or hybrid securities like converts to finance a share buyback, so interest income on cash, cash interest expense on new issuance and tax benefit from increased expenses must also be taken into account.
Usually, for share buyback, we do an accretion/dilution analysis to see how accretive or dilutive the effect of raising capital (bank debt, high yield debt, converts, etc.) is in accordance with decreasing the amount of shares with buybacks. So your net income will be affected by the items mentioned above, but your share count has decreased, so depending on which has a larger impact, your forward EPSwill either increase or decrease.
Bernank - that's not correct. The book value goes down by the total amount spent on the buyback - this is where bv vs mv usually gets confusing. The credit in your example is $250k to cash, and the debit is 250k to equity. That's why you sometimes see companies with a huge negative Tstock balance - its because the balance reflects current market prices, while the initial common stock and apic balances reflect the issuance price.
So there are two ways to answer your q:
from a BV perspective, levfings is exactly correct - it should be pretty clear that ROE goes up as NI is divided by a now far lower shareholders' equity (assuming the incremental interest expense or lost interest income impact on net income isn't significant).
From a MV perspective the question is a little different, and more interesting. When a company uses its cash to give back $ to investors, it is essentially saying "this is the best use of our cash". In other words, either because we think the stock is currently undervalued (good sign) or because we dont have any good investment opportunities as a firm (bad sign) a buyback is the best thing we can do. How the market reacts to that (i.e. whether the shares go up or down) is what will determine the market driven ROE.
So with this line of thought...you could technically have a firm with either zero or negative shareholder's equity? In which case ROE or ROC would be completely meaningless?
Thanks for the input.
bump
I mean yes you can have negative equity. I've seen it a bunch of times.
Also on the above, it's also these principles that make a share buyback and paying a cash dividend equal same in value to shareholders.
Share Repurchase (Originally Posted: 06/25/2013)
Say Company A has 200M shares outstanding, and each share is trading at $5. If it announces to buy back 50M of its shares. At what price will its shares be trading at?
$6.67
Follow up question: so why, in real life, share price for Company A only goes up to $5.5?
Because something else happened separate from the repurchase. And/or they didn't repurchase 50M shares all at once.
Knowing nothing else I'd guess $5.75 so +15%.
25% of shs outstanding is pretty hefty and most companies tend to do this over a few years whenever they announce something like this. I'd guess 3 years as extremely aggressive and 5 years as aggressive. During this time they also usually issue more shares. Although they increase EPS this way through reduced share count, they could be using the money towards other opportunities if they were present.
But the answer they're expecting is probably 0
don't you need EPS for this? you get the current P/E ratio, assume it to be held constant, and then multiply by the new EPS to get the price.
That's what I thought as well. But interviewer apparently thinks there's some other way to figure this out...
I think you guys forgot to account for the cash they are spending. New price= (2005-50new price)/150= 6.67 -1/3*new price = 5. Share price will go up or down whether the market thinks it was a good decision or not.
Spending cash to buy back shares does not show up on income statement. EPS will go up because shares outstanding are reduced now. P/E should remain the same, so the new share price should equal EPS(new) times P/E ratio. Though I think using EPS isn't very accurate since we should probably take out interest income/expenses. Any thoughts?
Classic WSO thread, first answer is correct and then every college junior and summer intern jumps in with absolute stupidity
Logistics of Stock Buyback? (Originally Posted: 09/18/2013)
Can anyone explain the logistics of how companies actually execute stock buybacks?
Say a company has a $10B share repurchase program over the next two years. What freedom do they have in timing? If the stock starts dropping, can/do they start buying back then to prop up shares, or do they usually have a pre-planned course of repurchasing? What are the SEC regulations? Do they use derivatives? Thanks.
I'll try to answer this as far as I understand it. Someone please correct me where I am wrong.
It is my understanding that there are a few separate types of Share Repurchase methods.
There is the Open Market repurchase method, whereby a firm is able to repurchase shares of their stock in the market without announcing it to the public. The mechanics of this are that market conditions dictate whether, when, and how much a firm seeks to repurchase. This process can span several days to several months. The firm is limited in the amount that they can buy back daily based on the ADTV (average daily traded volume), where they can only repurchase x% (e.g. 10-25%, based on other constraints) of the average traded volume.
The next type is a tender offer, where a company designates a specific amount of cash to be used for share repo and presents a range they'd be willing to repurchase stocks at (e.g. between 55-60). Then shareholders are presented with this offer and have the option to sell back their block of shares at a specified price. It is up to the firm to determine the optimal amount of share to repurchase, at the cheapest price, to come up with the most appropriate blend.
Then there is an Accelerated Share Repurchase program. This occurs when a company hires an Investment Bank to go out into the market and repurchase their shares, paying a premium to the bank for their services. Basically, the firm gives the bank money (e.g. $1B) and says "please buy back as many of our shares as you can." In this method, the risk is transferred to the investment bank, and in turn, the firm pays a premium to the bank. The bank essentially borrows the shares from clients/institutional investors, then sold back to the firm. i.e. The bank just uses the cash given to them to pay for the shares they're 'borrowing', and gives them back to the firm in the open market. This method is usually the fastest method, and allows for greater freedom in repurchasing stocks (i THINK).
There are a couple rules that the SEC has enacted. I'm not too familiar with all of them. For example, though, corporations have blackout periods whereby they aren't allowed to repurchase shares due to the issue of insider trading. These sorts of blackout periods are usually around earnings releases and things like that. However, there is SEC rule 10b5-1, which allows the Investment Bank in an accelerated share repo to repurchase shares even during blackout periods.
There's another rule, rule 10b-18: The rule breaks down as follows: Manner of purchase: The issuer or affiliate must purchase all shares from a single broker or deal during a single day. Timing: An issuer with an average trading volume less than $1 million per day or a public float value below $150 million is unable to trade within the last 30 minutes of trading. Companies with higher average-trading-volume or public float value can trade up until the last 10 minutes. Price: The issuer must repurchase at a price that does not exceed the highest independent bid or the last transaction price quoted. Volume: The issuer can't purchase more than 25% of the average daily volume.
Hope this helps. Again, I'm not 100% sure on this but I worked on share repo models over the summer at my internship so most of this should be right.
cheers
Share Repurchase and Book Value Per Share - Help (Originally Posted: 08/11/2016)
Hi,
I came across this question about share repurchase/book value per share and would like some help. Can't seem to get the right answer for some reason.
If a company buys back shares at $9 per share and book value per share is $13, by what % does each dollar spent on share repurchase increase book value per share?
I got 30% as the answer, as follows: if there are 10 shares @ $13 book value each, total book value of company is $130. Assume company buys back 5 shares at $9 per share for a total of $45. Assume company uses cash to finance repurchase. Total book value of company is now $130-45 = $85. Shares outstanding is now 10-5 =5 shares. Book value per share is now $85/5 = $17. So book value per share increased by $4 due to share repurchase, from $13 to $17. In terms of % increase, 4/13 = 30.8%.
But the correct answer is 44%.. Anyone knows how to get 44% or what I did wrong?
Would really appreciate any help here!!
(13x-9x)/9x= 4/9 = .44
when you buy stock for x amount of €€ at 9/share, you consumed 9x/s in cash and thus reduced book value by 9x/s hence the -9x. at the same you added 13*x/share to book value thus the added value is x(13-9). dividing by 9x is just to get a %
What does EUEU mean?
Thanks for your replies! Just to clarify, I understand intuitively why book value should increase when the share repurchase price is less than book value per share, but from an accounting perspective, why is this the case? What kind of journal entry would be involved?
I was thinking something like this: Dr. Treasury Shares 13 (contra-equity account) Cr. Cash 9 Cr. Common Stock 4
But I'm not sure if it makes sense that attribute the remaining $4 per share to common stock? Or is it credited to retained earnings?
What actually happens during a stock repurchase of a company? (Originally Posted: 07/04/2016)
Can someone explain what really happens during a share repurchase of a company in the open markets. Let's say your company's stock has fallen from $100 to $80 in the last 12 months and it may have just been some short term pressure in the industry and a sales miss...who makes the decision for a company to buy back shares and what purpose does this serve?
I am having trouble understanding the whole transaction side of this and where the value is added for a company's shareholders. In theory, if a company has 1000 shares outstanding but only buys back 100 shares at a higher price, what value do the other shareholders get whose shares were not repurchased? Hoping someone can explain this entire process in detail! Thanks again
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