How Do Stock Buybacks Affect Stock Prices?

I saw a question on Quora about how stock buybacks affect stock prices, and couldn’t resist.

Do Buybacks Artificially Inflate Stock Prices?

Bathroom ScaleA stock’s price is supposed to reflect the value of the company. If a company has a million shares outstanding, and the stock price is $10, then the market is saying “this company is worth $10M.”

If that company then took some of its cash on hand and used it to buy back some of its own stock – say 100,000 shares – then the rest of the shares would theoretically re-price to reflect the $10M valuation.

The problem with that theory is that the cash which was part of the $10M valuation is now gone. The revaluation of the remaining stocks doesn’t make much sense because of the reduced cash-on-hand. The argument, (which I accept), is that the cash could have been used for more productive concerns which would have raised the profitability of the company which would then almost certainly be reflected in an increased stock price.

Stock buybacks bypass¬†all the hard work of making the company more profitable. It is akin to a fat person modifying their scale to display lower numbers so they don’t have to do the hard work of actually losing weight.

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