Share Buybacks 101 -- and Why Facebook Is Spending $6 Billion On Its Own Stock

By Motley Fool Staff Markets Fool.com

Facebook (NASDAQ: FB) recently announced plans to buy back $6 billion worth of its own stock, surprising a lot of investors.

Continue Reading Below

In this clip from Industry Focus: Tech, Dylan Lewis and contributor Daniel Sparks explain what stock buybacks are, and what a high-growth tech company might want from them. Find out some of the most common reasons that companies buy back their stock, what a company like Facebook has to gain from them, and how much sense this move makes for the social giant right now.

A full transcript follows the video.

Find out why Facebook is one of the 10 best stocks to buy now

Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)

Tom and David just revealed their ten top stock picks for investors to buy right now. Facebook is on the list -- but there are nine others you may be overlooking.

Continue Reading Below

Click here to get access to the full list!

*Stock Advisor returns as of November 7, 2016

This podcast was recorded on Dec. 2, 2016.

Dylan Lewis: Facebook said it plans to buy back $6 billion worth of its own stock. I think that surprised people a little bit.

Daniel Sparks: Yeah, it definitely came as a surprise to me.

Lewis: Yeah, you typically think of some high-growth tech company as one that will not be spending cash on its own shares. What are some of the terms that they announced?

Sparks: It's a $6 billion program, goes into effect in the first quarter of next year. There's no expiration date on it, or no stipulations as far as the timing goes. Management seemed to suggest that the stock price would matter. They did mention that as one of the factors that would determine how much they're buying back. But at $6 billion, that could be somewhat just to offset stock-based compensation. We'll talk about that in a little bit. But, this is a $320 billion market cap company. $6 billion isn't too big. But it is notable. They have $26 billion on their balance sheet right now, of which $4 billion is overseas. So, they do have the cash to spare, they have free cash flow coming in. That's it in a nutshell.

Lewis: Yeah. Very often, with these announcements, you'll see management say, "We will buy back shares opportunistically." That is that element of timing you're talking about. Seeing times they think shares might be undervalued. As a refresher on buybacks for investors who might be a little newer to the game, basically this is when a company buys back its own shares from the marketplace. There are a couple main reasons why they might choose to do this. One of them mainly being they believe the company is currently undervalued, so they believe buying them at a discount is accretive to shareholders, as it reduces the number of shares outstanding, but also boost EPS (earnings per share), which people always love.

One of the other main reasons you'll see -- and I think this is something we'll see as a common thread with a lot of tech companies we'll talk about today -- is, it's a measure to offset the growing shares outstanding number. When you look at an industry where stock-based compensation is extremely common and tends to balloon, you see a lot of tech names using buybacks as a mechanism to reign in a rising share outstanding number.

I'll say, also, it's something that's kind of fairly common for more mature companies, companies that tend to have a decent amount of cash sitting around. I think part of the reason people were a little surprised to see this from Facebook is, like I mentioned before, you don't see a lot of high-growth relatively young public companies set up buyback programs. A lot of times, these businesses are so preoccupied with the cash that they're generating and taking it and reinvesting it back into the business in new initiatives, things that will fuel top and bottom line growth, that more Wall Street friendly moves like share buybacks or capital return programs, more broadly, aren't even top of mind for them. What are your thoughts on this, Daniel?

Sparks: Like I said, at $6 billion, I do think this is not necessarily a capital return program, like you might think of Apple's, which goes to reduce the total share count. When we look at stock-based compensation in the 12 trailing months, it's over $3 billion. 2015 was just under $3 billion. Then, 2014, Facebook paid stock-based compensation of just under $2 billion. When you look at this trajectory of Facebook's stock-based compensation, it looks like when the company authorized $6 billion, that their stock-based compensation could potentially even equal $6 billion in 2017, when the program starts, especially considering how fast the company is growing, and that next year is supposed to be a big investment year. My general thoughts on this are, it does make sense, because Facebook is generating more cash flow, and like I said, it was a surprise when they first announced it, but after you begin to think about it, you see, Facebook does have a lot of cash, they're paying out a lot in stock-based compensation, but yeah, it's not necessarily capital return. It's more offsetting the dilution that comes with the massive stock-based compensation of retaining talent in Silicon Valley.

Lewis: Yeah, if you look at their shares outstanding since going public, they've gone from around $2.1 billion in 2013 to close to $2.9 billion now. That gives you an idea of stock-based compensations impact on the business, and their hopes that they can reign that in a little bit.

Daniel Sparks owns shares of Apple and Facebook. Dylan Lewis owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Facebook. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.