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Let's say a company has a market cap of $11 million, 1 million shares outstanding, no debt, and $1 million in cash. Right now, if I am an investor, I own some shares that are worth $11 each. If the firm repurchases shares at $11, the stock price will remain at $11 the number of shares goes down proportionally to the decrease in equity. But then why would firms even do this? In either case I would have shares worth $11. Sure, some people might get cash, but couldn't they sell it at $11 in the market anyways?

This is the exact example one of my textbooks gave, and I am not sure what the benefit would be.

Vasting
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    Supply and demand: reducing the number of shares available to buy can increase the value of the remaining shares. Unlike shares sold on the open market, they don't become available to other interested buyers; they are effectively "consumed", unless the company reissues stock at a later date. – chepner Jul 04 '19 at 21:51
  • @chepner No, not unless the company file a request to cancel the share. Some company simply purchase it as an investment or for other reasons. – mootmoot Jul 05 '19 at 11:18
  • Here is the complete answer for the practice.
    https://www.investopedia.com/terms/s/sharerepurchase.asp     – mootmoot Jul 05 '19 at 11:21

2 Answers2

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A company's shareholders want it to make the most prudent use of its assets. The amount of capital that the company can use effectively (returns above the cost of capital) at a given time determines the optimal size of the company.

If profits exceed the amount that the company can usefully reinvest in its business, money should be returned to shareholders so they can invest it elsewhere -- preferable to keeping it in the corporate cash account, or over-expanding the business with loss of profitability.

Dividends and share repurchases are the two typical ways to do this. The decision between the two involves financial engineering and taxation. Repurchases particularly make sense if the company believes its stock is undervalued. Individual shareholders could sell on their own to market buyers, but this does not achieve the desired reduction in outstanding shares (size of the company).

nanoman
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The company might believe its shares are undervalued on the market.

Most of the time in the US companies do share repurchases on the open market. For you as an investor, selling in a share repurchase is not really different than selling to anyone else on the market.

As you noted, in theory because equity decreases proportionally to the number of shares outstanding, since the company is spending down its cash balance to buy shares, the share price should not be affected.

But the the share price might go up for a couple of reasons:

1) Increased earnings per share (I believe in theory this is counterbalanced by weakening of the company's balance sheet, but many investors care a lot about EPS)

2) The company is signalling that it believes its shares are under-valued. If Apple themselves believe Apple shares are under-valued, that would be a pretty good reason to adjust your valuation upward.

It seems like on average selling in a repurchase should be a bad deal, since the other side of the trade - the company itself - is the ultimate insider, and the company deciding to do a repurchase based on insider information, is, as far as I can tell, not illegal.

JBGreen
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