Are share buybacks an indication that a company is trading on the cheap, or a sure sign that management has run out of good business ideas?

In this episode of The Fat Wallet Show, I try to figure out how share buybacks affect investors. From time to time, a company will buy and destroy some of its own shares. While the reduction in shares theoretically reduces the amount of claims on dividends, is this type of corporate action really in the best interest of shareholders?

I’m surprised to learn that share buybacks happen on the open market at market value. Doesn’t that indicate that a company is trading below its net asset value? Wouldn’t that be my cue to jump in and grab shares at a reduced price? Simon isn’t convinced.

I think it comes down to a bigger question: Why did I buy this share to begin with? If I hold a share because I understand the business, believe in its ability to make money in the future and think the management team know what they’re about, the buyback might be an opportunity for me to pick up some more. If I hold the share as part of a momentum portfolio, on the other hand, I might see the buyback as an uninspired use of free cash. The moral: know thy companies.

Kris