RE: Cancellation of shares24 Mar 2021 08:49
Saw this example a while ago and some may consider the buybacks as negligible given the number of shares in distribution but they wouldn't be doing it if didn't prove advantageous!
Imagine a business makes $1,000,000 a year and has 10 partners who each own 10% of the business. This business pays out 50% of its profits ($500,000) every year to its owners. Each owner gets $50,000 a year.
Now imagine that one of the partners wants to ‘cash out’. Everyone agrees the business is worth $10,000,000 (a 10x earnings multiple). The business spends $1,000,000 in excess cash to buy out a partner.
After the buyout, the business is still making $1,000,000 per year and paying out half of that money to its 9 remaining owners. The only difference is that now each owner now owns 11.1% of the business because 1 of the owners was bought out.
Instead of receiving $50,000 a year, the remaining 9 owners will receive $55,556 a year even though the business did not grow. What did grow is the percentage of ownership of each remaining member of the business.
The ultimate goal of rational shareholders is to maximize the per share value of the business.
Share repurchases increase per share value by reducing the number of shares outstanding. Said another way, share repurchases increase your percentage ownership in a business.