What Are Stock Buybacks? Here's How They Make You Money

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Stock buybacks? What in the world are those? 

Who's buying the stock back and when did they hold it initially? Okay, it's a company that is buying stock back, stock that it had initially issued to investors when it went public. 

So why should you, the investor, care? 

First off, this is something you should know about to become a smarter investor. Here's the point: share buybacks often are money makers for investors. 

When a company buys its shares back, the value of the shares often goes higher. 

If there are 100 shares outstanding in company 'X,,' and X is worth $200, then each share is worth $2. 

If the company buys back 10 shares, you're down to 90 shares outstanding, but the company is still birth $200.

The $200 equity value is unrelated to the share count.

The $200 equity value s based on future profits. Now, with 90 shares representing $200 of value, the share price moves up to $2.22 from $2 previously.

Let's relate this to something you've all dealt with before. 

Premium Read that shows buybacks in action: Jim Cramer: How CEO Kevin Johnson Fueled Starbucks Breathtaking Numbers

Layman's Terms

What if you had $500 to spend in a month. But that party you were budgeting for got cancelled. You sent $400 and had $100 of excess cash. Are you going to just let it sit there? You could do that, but you could also try to increase your own stock price. 

You don't have any external shareholders of your own net worth (the only one is you), but you do have friends you might owe money to. Pay your friends back and see your own stock go up. 

How it Works Technically 

A company has an amount of cash to spend for the coming period. It has operating expenses and long-term investments. But what happens if it has cash left over, or 'excess cash?' Just leave it there? Stuff it under the shareholders mattresses? Nope. The company wants to put that money to work while getting that cash back to shareholders. If the company buys its own stock back from the market, that cash is going into an asset that can appreciate (the stock). Meanwhile, shareholders saw the shares they still hold move up in value. 

So bottom line - the next time you hear a company might initiate a buyback program, maybe you should consider buying the stock. 

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Editor's Note. This article has been updated. It originally published on July 26, 2019.

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