So let's use company XYZ as an example. XYZ has a market cap of $1B, $500M in cash, 1M outstanding stocks valued at $1000.
Let's start with the following premise: The market cap of XYZ is equal to the intrinsic value of the company plus its cash balance. (500M+500M=1B)
Company XYZ decides to use all of its cash balance to buy back stocks and destroy them. According to what everyone says this should make the stock double in price because there will be half the number of outstanding stocks.
What I don't understand is that according to our premise the stock value should remain the same since the intrinsic value of that company hasn't changed. The new market cap is 500M+0=500M because the cash balance is now empty. However there are now only 500k outstanding stocks so they still each worth $1000.
So if this reasoning is right company XYZs buyback would only slightly pump the stock price from buying on open markets and as soon as they are done the price should go back to its actual value, essentially giving all that money to traders selling the pump.
Please explain if I'm wrong thanks!
Submitted August 05, 2018 at 01:11PM by gragato https://ift.tt/2MkmokI
