The stock market is in fashion during the pandemic – Nasdaq100 made a new all-time high, while the S&P500 and Dow Jones are close to the same. The recovery is nothing short of amazing, considering that it comes after the fastest bear market in history.
Few traders remember, though, that back in March, when the market was in free-falling and triggered the circuit breakers on a daily basis, panic led to extreme proposals. One such proposal was to shut the market down. It happened in the past – it could very well happen in the future. Shutting it down for a while until investors calm down and then restart the game. Not quite possible in the 21st century when trading algorithms dominate the price action, but it was news circulating at that point.
Another proposal was to forbid companies to buyback their shares. In some cases, it was applied, but it still represents a great way to maximize shareholders’ wealth. Intel just announced a $10 billion buyback program, sending its stock price higher.
What Is a Buyback, Why It Affects the Share Price and Why It Is So Controversial?
A company has many reasons to buy back its common shares. Among them, it may choose to buy them back because it views them too cheap. As such, providing it has the cash to pay for them, it announces buyback programs to purchase common shares as the management believes the market price does not reflect the intrinsic value.
Buyback programs support the share price in the sense that investors are aware that the company is bidding for its shares. Moreover, investors suddenly find out that the management views the share price too low, and further appreciation in the share price is expected.
Why is it controversial? First, buybacks were considered illegal back in the day. They were viewed as actions meant to manipulate the stock price. Second, most of the companies that failed during the COVID-19 pandemic (e.g., airlines, cruise liners, etc.) asked for bailout money from the taxpayer. But, at the same time, in the last years, the management ran huge buyback programs and used the free cash flows as such. When a crisis came, no cash remained for the company to continue its operations.
But buybacks reflect pure capitalistic decisions. Just like dividends, they are a great way to increase shareholders’ wealth.
Intel’s announcement is just a reminder that capitalistic principles are alive and kicking.
Long live the stock market.