Some investors may be asking, “Why would Microsoft or any company, buy its own stock off the open market?”
There are several possible reasons, but let’s look at what effect it has on stockholders. Under most circumstances, stock repurchase plans benefit stockholders.
The reason is fewer outstanding shares mean the remaining shares are worth more. Think of it as cutting the pie into six pieces instead of eight pieces. The company doesn’t change, but the value of your stock does, because there are fewer shares outstanding.
Off the Street
The company either cancels the stock it buys back or puts it in the treasury – either way, it is off the street and no longer involved in the business.Now, what motivates a company to repurchase some of its shares?
The usual answer goes something like it is the best investment option for the company’s money at that time. Managers are charged with creating wealth for the shareholders.
Part of that responsibility is deciding what is the highest and best use of cash is for the company. The usual corporate explanation is the buyback was the best investment of the money at the time and it provided shareholder with additional wealth by increasing the value of their stock.
Good Reasons
There can be other reasons, of course. Some are not so good.Companies may want to make their ratios look better. Metrics like price earnings ratio, earnings per share, return on assets, return on equity and others can be pumped up by a stock buyback program.
The problem is nothing has fundamentally changed about the company. If there were weaknesses in the business model before the stock buyback, those weaknesses will still be there after the buyback.
Another problem stock buybacks seek to cure is the dilution (too much stock on the open market) caused by too generous stock option plans. When stock options are exercised the number of outstanding shares increase. This makes the company’s ratios look weaker – the opposite of what repurchasing does.
In Microsoft’s case, the company has been sitting on a huge bankroll of more than $34 billion in cash. With no major acquisitions in sight or legal settlements pending, the company can’t, in good faith just let the money sit there. It needed to either invest it in something that created wealth (an acquisition, for example) or return it to shareholders in the form of a dividend or stock buyback.
