Saturday, 25 February 2012
Sometimes a company has surplus funds that it does not need for its operations. It can use those funds to expand its operations (eg buy new businesses) or it can distribute them to stockholders. One way of distributing funds to shareholders is to have a share buy back, wherein the company buys back some of its shares from existing stockholders.
Company A has 100 shares issued and makes a profit of $50. This means a shareholder is getting a return of 50 cents a share ($50/100). This is the Earnings per Share or EPS. If the share sells on the stock exchange for 15 times its EPS, a share has a value of $7.50.
Suppose that the company buy back 25 shares. A shareholder who retains their shares now earns 67 cents ($50/75) on each share held. If the share sells on the stock exchange for 15 times its EPS, a share has a value of $10.