Posts Tagged ‘share buy backs’

The Financial Times today reported that companies are buying back their own shares at the highest levels in a long time.  What does this financial decision signify to you?

When a company buys back its shares it is using cash generated from the business to buy its own shares on the stock market and effectively take shares out of the market thus reducing the number available.  Why do they do this and what does it mean?

If you own shares in the company (remember if you hold a mutual fund or index fund you could be a shareholder indirectly) then this reduction in shares increases the value of each share still available (because the profits of the company are shared by less shares) and therefore the price will go up and you will be able to make more money when you sell them (this is a known tactic for giving profits back to its shareholders).

However, what does it communicate to the rest of us about the all-round economic outlook?

Firstly, that the share prices of the companies are low. Companies want to buy shares when they are cheaper as they can sell them again when they are higher and make a profit (for their shareholders), this would imply that the companies feel they are currently undervalued.   It also tells us that companies have cash to buy shares meaning that they are starting to build up cash, this is probably due to the cost-cutting initiatives that have taken place over the last few years.  Companies are now being run a lot leaner.  This is in stark contrast to a couple of years ago when companies were struggling with cash flows.

However, it also means that companies are choosing to give the money back to the shareholders rather than reinvest the money in the company and growth opportunities.  Therefore this is seen as a conservative financial decision and one we should be aware of for the future as they are not reinvesting in company growth.

So, what we could take from this news is that the stock markets could be seen as well-valued, some companies now have more cash in the bank than the last couple of years but we have to be aware that the recovery could take a little while as they still do not see as much growth opportunities in their businesses right now.   Has this news changed your views of the economy or just reinforced what you already thought?