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Buybacks may help stock value

Q: I have owned bank stock for many years, and recently the bank company announced it is going to buy back some of its stock. What is the purpose of this?

A friend of mine indicated he believes it will reduce the number of shares and result in a better value. Is that a correct assumption?

A: Your friend is quite correct on his first point and, most likely, on his second.

Keep in mind that each share of stock outstanding _ owned by an investor _ represents a share of ownership in a company. If that bank or any other company had exactly 1,000 shares outstanding and you owned 10 shares, you would own 1 percent of the company.

If the company in our example bought back 100 of its shares, leaving 900 outstanding, each of the outstanding shares would then represent 0.11 percent of corporate ownership. Assuming you did not sell your 10 shares in the buyback, your share of ownership in the company would increase from 1 percent to 1.11 percent _ a gain of 11 percent.

The stock buyback did not change the company's operations. The company's total value is the same as before. Because each share represents 11 percent more ownership, the share value should rise by that amount _ your friend's second point.

That's the result of most stock buybacks. As always, however, day-to-day stock prices are determined by buying demand and selling pressure in the marketplace.

Of course, the typical corporation has millions of shares outstanding. The example above makes for simple arithmetic.

Q: When a company wants to buy back some of its stock, how is this accomplished?

A: The company has two basic choices.

One is to purchase the shares in the open market, buying them in transactions on exchanges or the over-the-counter market. The over-the-counter purchases might include buying large blocks of the stock from major stockholders.

The other way is through a "tender": Announce that the company will buy a certain number of shares at a fixed price and invite shareholders to tender their shares. If the total number of shares tendered exceeds the number the company wants to purchase, the company buys a pro rata amount from each responding stockholder and returns the rest of the shares.

Occasionally, a company will announce an offer to buy back small amounts of stock, such as fewer than 100 shares, from individual stockholders. Such offers, at higher than the going market price, last for just a few weeks. Rather than the reduction of total number of shares, these offers aim at decreasing the number of small shareholder accounts, which are just as expensive to maintain as large accounts _ except for the size of dividend payments.

Q: What happens to stock a company acquires through a buyback program?

A: It becomes "treasury stock" and is held in the company's treasury, where it is treated the same as authorized but unissued shares. As such, it receives no dividends and has no vote at stockholder meetings.

William Doyle welcomes written questions, but will be able to give answers only through the column. Address questions to William Doyle, King Features Syndicate, 235 E 45th St., New York, NY 10017.