Not discussed enough is the effect stock buybacks are having on the stock market over the last several years. The concept is simple. Corporations buy shares in the open market the same way ordinary investors do, however, when corporations do it, they ‘retire’ these shares leaving fewer shares outstanding. Each remaining outstanding share then represents a larger piece of the corporation. Therefore, when total earnings are reported a smaller number of shares divide into them. This increases earnings per share more than total profit of the corporation would indicate. Share prices then rise accordingly with the increase in earnings per share. Additionally, buying shares in the open market provides a further boost to share price.
However, this may be sacrificing long-term growth for short-term gains. Corporate cash used for stock buybacks is diverted from investing in additional opportunities,i.e. of buying plants and equipment and employing more people to create more profits over the long run. Corporations are even borrowing to finance stock buybacks; putting more and more debt on their books for future managers to deal with. Activist investors concerned only with immediate gain are forcing the issue. Managers who do not implement buybacks are soon unemployed.
Stock buybacks are a major component of what is driving the stock market to record valuations. It also helps explain why the market is soaring while full-time jobs have not recovered to pre-recession levels.