Stock Buybacks: Benefits Of Share Repurchases
This will increase ROA, although earnings don’t change. Prior to the buyback, the corporate’s ROA was 4% ($2 million ÷ $50 million). After the repurchase, ROA increases to 5.71% ($2 million ÷ $35 million). A similar effect may be seen for EPS, which increases from 20 cents ($2 million ÷ 10 million shares) to 22 cents ($2 million ÷ 9 million shares). The buyback also improves the company’s price-earnings ratio (P/E), which is one of the most well-known and infrequently-used measures of worth. At the risk of oversimplification, the market usually thinks a lower P/E ratio is healthier. Therefore, if we assume that the shares stay at $15, the P/E ratio before the buyback is 75 ($15 ÷ 20 cents). After the buyback, the P/E decreases to sixty eight ($15 ÷ 22 cents) as a result of discount in excellent shares. EPS, which results in a greater P/E. Based on the P/E ratio as a measure of worth, the company is now cheaper per dollar of earnings than it was previous to the repurchase regardless of the fact there was no change in earnings.
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