As US airlines are accused of buying back shares, I thought it might be helpful to explain what buying back shares really means, and why you might want to sell and buy shares at all, if you’re a company.
The airlines are being criticized because they might become short of cash now, as people stop flying and as the economy overall is likely to slow significantly. [That’s right, this is the third COVID-19 post in a row because, let’s be honest, no-one’s thinking about anything else right now].
What are shares?
A share is the title or deeds to a part of a company. If you are the CEO of a company that is worth $100 (just to make the mathematics easier) then you may wish to sell 40% of your company for $40 so that you can spend the $40 on making more money. If you invest that $40 wisely, then the company may grow to be worth more than $110 in a year’s time, and you have grown the company by 10%.
If the company has made more money, it might pay more or less than 40% of its profits to the shareholders through a dividend. Shareholders buy shares so that they can make money by seeing the price of their shares grow and/or by receiving dividends from their shares.
Buying back shares
If, by making more money, the company now has spare cash in its coffers, it could either use that money to make more money – investing it in new systems, new products to sell, or more staff to improve service – or it could buy back some or all of the shares.
If your company is now worth $110 then the shares that you sold for $40 are worth around $44. In the real world, as shares are bought, the perceived demand for them pushes the price of remaining ones higher, so after the company bought one share, say for $4.40, then the next share might cost them $4.41, etc.
By buying back shares, the company regains control over its decisions, and does not have to pay out as much in dividends. It also increases the share price, which might make people who work in the company richer, especially those who own large numbers of shares such as directors.
The problem for the airlines
The difficulty for airlines now, is that their shares are not worth as much as they were before because almost all shares have lost a lot of their value (more people are selling than buying) as investors worry about the economy during the COVID-19 pandemic. If the company needs to raise cash now, it can sell shares again, but they are going to get a lot less money for those shares.
If the hypothetical company above is now worth only $60, then each share that was worth $4 originally, and which was worth $4.40 after the ten percent growth, is now only worth $2.40. If the company was to sell 40% of its value again, it would only get $24.
If it had kept the cash, or invested it in growth, it might still have $40, but in our entirely hypothetical scenario, they have effectively lost at least $16.