Why GE opted for Buyback of shares

I just happened to read through an article on GE on buyback of its shares. I thought to put my thoughts as to why this decision has been made.

One of the biggest decisions which any firm has to make is to consider the option of buying back the firm's shares. The following points make firms to opt for a buyback:

1. If the Firm is sitting on pile of cash.

2. To make their stock look attractive.

3. Change the structure of their capital (Debt/Equity).

4. To project a better financial ratios.

Let us consider GE in this case. GE has to buyback its shares due to the poor performance of its subsidiary firm GE Capital. GE Capital suffered due to recession which took place in the year 2008. It invested in many alternative investments. One such investment is real estate. The credit markets froze due to the falling prices of real estate and GE couldn't fund its day to day operations. The result of this is the drop in day to day activities, layoffs, profit margins etc. Due to the recession, the financials of GE have taken a hit and eventually led to drop in share price.

How does buyback help GE

·         Buyback of shares increases the key ratios of GE. Earnings per share of GE will increase since the number of outstanding shares in the markets goes down which in turn increase the value of EPS.

EPS = (Net Income – Preferred Dividends) / Outstanding number of shares

·         Return on Assets (ROA) will also increase since cash is considered to be an asset and GE has to pay existing shareholders with the cash to complete the buyback.

ROA = Net Income / Average total assets

·         P/E ratio is considered to be attractive when it is low. Due to the buyback, the EPS will increase which in turn decreases the P/E ratio of GE.

P/E = Market Value per Share / Earnings per Share (EPS)

·         The existing shareholders who are holding shares will have an advantage since GE will buyback the shares at a premium and shareholders who are in favor of buyback will earn good amount of profits.

·         Any long term investor would always use the fundamental analysis as his/her weapon while choosing a long term investment and the fundamental analysis includes these key ratios as well.

·         Once the investors look into these financials they feel all the more attractive towards this stock and keep buying the shares which have now increased in value as the buyback has happened. Once GE gains back the investor confidence again, they can go for a an FPO (Optional) and raise money so that they can payback their debts which in turn increases its working capital efficiency.

·         Since the economic conditions were poor for a period of time after recession , the stock value of GE is undervalued. Buyback will help the stock price to rise and remain competitive.

One important thing to be considered after buyback is the share price. Initially the share price may increase but gradually it might decrease as well. Investors should analyse carefully and then proceed with the investment.

Overall, GE remains a good stock pick for the investors due to varied reasons such as its brand value, diversity in business, long standing history of the firm etc. My opinion for a profitable long term investment for any investor is to include GE in his portfolio of stocks.