Friday, November 14, 2014

What do stock buyback actually do?

Barry Ritholtz passes along an interesting thought from Aswath Damodaran, a professor at New York University.
Before a company calls for a stock buyback, it has risky assets (its operating business) and riskless assets (cash). After the buyback, the company has less of its riskless asset (cash) but also has fewer outstanding shares.

Hence, we end up with a somewhat riskier stock. Damodaran argues, rationally, that a buyback by an all-equity funded company should be a value-neutral transaction. In other cases, the shift should be reflected in by assigning the company a somewhat lower price-earnings ratio.
I don't know enough to comment intelligently on this claim, but it does seem to indicate that, as with so many other stories, the impact of buybacks is considerably more complicated than the experts on CNBC would have you believe,

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