Berkshire Hathaway, Apple Among Companies That Buy Back Shares
In 2020, Berkshire Hathaway (run by Warren Buffett) bought back nearly $25 billion worth of its shares.Since 2013, Apple has spent hundreds of billions of dollars to buy back its shares.
The question many people have: why would a company buy back its own shares?
For Berkshire Hathaway, the answer is simple - Warren Buffett believes that if the company's shares are being undervalued by the market, he will use some of Berkshire Hathaway's cash to buy back shares.
After all, Berkshire Hathaway has mountains of cash, and Buffett has publicly groused that finding good deals in this stimulus-driven environment is exceptionally difficult. So why not buy shares of his own company if he feels that they are undervalued?
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Cash-rich companies will often buy back shares or pay dividends in order to make use of their cash. Shareholders demand returns, and buying back shares is a great way to increase Earnings Per Share and subsequently the price of the stock.
Companies will either wade into the open market to buy back shares or arrange deals privately. These shares are then cancelled, which increases the value of all of the remaining shares.
Let's say that a company was earning $1 billion in profit per year, and there were 1 billion outstanding shares of the stock. The company has a large cash pile of $10 billion.
Let's say that the company buys back 5% of its shares over the course of a single year. The company is STILL earning $1 billion in profit per year. The difference - there are now just 950 million shares of the stock outstanding, compared to 1 billion shares the year previous.
The company is now earning $1.05/share, which means that the value of the stock will increase, assuming that the market gives it the same Price/Earnings ratio.
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Companies don't even need mountains of cash to pull off a share buyback.
In fact, interest rates are so low, that some companies will literally borrow money to buy back shares.
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Warren Buffett smartly takes advantage of times when he feels that the market is undervaluing Berkshire Hathaway to buy back shares of the company.
In most other cases, however, companies will simply buy back shares just because they want to please shareholders and try to make the stock go up.
Filed under: General Knowledge
