Share Buyback of Own Stocks

A share buyback of the company's own stocks (share buyback / share repurchase) means that a company buys back its own outstanding stocks from the market. The bought stocks are withdrawn (retired) or kept as treasury stock.

The effect: the number of outstanding stocks decreases, which raises earnings per share (EPS) even if the total profit is unchanged.

Why do buybacks exist? Three main reasons: (1) Capital allocation — companies with more cash than they can reinvest profitably return the surplus to the owners. (2) Signal — management buys back when they believe the stock is undervalued; the market interprets this as 'insider confidence'.

(3) EPS optimisation — fewer stocks raise EPS, which (theoretically) raises the share price if P/E is unchanged.

A 'good' buyback has three hallmarks. First: it is financed with free cash flow, not with debt. Companies that borrow to buy back stocks increase their debt (V10) and risk crises. Second: it happens at a price below the company's intrinsic value. If the stock trades above intrinsic value the buyback destroys value — the company pays 100 for something worth 80.

Third: it does not replace necessary R&D or capital investment. A company that skips R&D to finance buybacks is eating its future.

Apple is the classic example of 'good' buybacks. Since 2012 Apple has bought back for over 600 Bn USD — financed with enormous free cash flow, at prices below intrinsic value, and at the same time as the R&D budget has grown.

Result: EPS has grown faster than profit, and the stock has multiplied many times.

AKM1 V20 scores buybacks according to these three criteria. Score 4-5: buybacks financed with free cash flow, at a price below intrinsic value, without eroding R&D. Score 3: buybacks financed with debt but at the right price — acceptable but not optimal.

Score 1-2: buybacks financed with debt, at a price above intrinsic value, or replacing necessary investment — value-destroying.