 Good day fellow investors. An MBA student subscriber to my platform has been constantly asking me a lot of technical questions and then I said okay instead of replying to him in an email let's make a video it will be much quicker and it will give give value to most of you. The question today is okay I said that buybacks are bad I really think 98% of buybacks are bad and then in the last video about Apple I discussed how Buffett is looking at the buyback yield so he understood that I'm positive about buybacks I'm now neutral about Apple buybacks but in general I'm very negative on buybacks so I'll discuss today what are buybacks how do they work why do management do them and then we'll discuss the story about Apple where I'm saying I'm neutral on buybacks so disclaimer there immediately but you will see a lot about how the stock market works how the management works how the investment current investment environment works and it is highly skewed on buybacks and you have to see individually for each stock that does them how does that work is it a plus is does it create value or it actually destroys value let's start so what are buybacks buybacks are when a company buys its own shares on the stock market as you cannot be your own shareholder those stocks are deleted this means that if a company has a 100 shares and the stock price is one dollar they have 10 dollars they buy 10 shares on the market now the number of shares outstanding is not 100 is 90 so less shares outstanding if their earnings stay flat now their earnings per share are immediately higher so that is a way to return money to shareholders because you're increasing the earnings per share thus you hope to increase the stock price thus you are doing good for shareholders right that is the logic behind those investments and then i mentioned the buyback yield what is the buyback yield for example if a company decides that the same company that they will buy back 10 dollars of value of shares every year so they will invest those 10 so you can expect that the buyback yield is 10 so if the the market capitalization is 100 dollars they buy back 10 so that buyback yield the return of to shareholders that they are giving back through buybacks is 10 so that's also a yield that you can calculate when investing and Buffett probably does because he likes those let's say cannibalists like Pabrai would call them that really buy back their stocks and have improving earnings have good businesses have long-term modes and those businesses really deliver a return to the shareholder that is significant whether it is good or not that's a big big debate let's analyze the market in general for buybacks and then discuss apple so this is why i'm really against buybacks this is sap 500 buybacks as you can see if you do a buyback you want the stock price to be as low as possible probably below book value because then you are actually increasing book value if you buy below book will value if you buy above book value you are destroying book value but that's another story you can see here that as the stock market peaks then the buybacks increase increase increase because the management is chasing their options they are trying to push the stock price as high as possible and very often in such situations they are destroying shareholder value because they should be buying doing buybacks when the stock prices are extremely low not when the stock prices are extremely high however if a manager comes and says oh we are not doing buybacks then it means that the stock price is overvalued and then the stock price drops and then you are fired so that's actually shareholders want stock prices to go up which is illogical in the long term but that's another story and the management also want stock prices to go up to get share options to think they are doing a good job but their job should be managing a business not financial engineering on stock markets which is a different story the problem is that the book value of SAP 500 average is 3.15 in 2008 was also around 3 and every time that someone buys back a stock they are practically buying their own equity and paying in this case three times more what it is actually worth from their equity perspective so the two-thirds are destroyed or the two-thirds of value go to the seller of the stock in apple's case apple has managed to lower its number of shares outstanding from 2012 when it had 6.6 billion to the last quarter 5 billion and then in the team cook letter we have seen it went to 4.7 billion so they really lowered the number of shares outstanding by 25 percent however let's look at how much they spent to do that they spent 203 billion on buybacks over the past six years so 47 dollars per share on an average number of shares outstanding so they spent 203 billion to lower the number of shares by 25 percent 200 billion the current market capitalization is 800 billion so they spent 25 percent of the current market capitalization to lower the number of shares outstanding by 25 percent so let's say they spent the money to do the same result that they have now from a market cap perspective if the market cap drops to 600 billion that means that oh then they have over spent if their earnings get lower then the stock price will be much lower and then you would see okay they did buybacks at 150 180 200 by but they could have done them at 100 and the buybacks at a high price will destroy stock holder value and this is always the story here you don't know what the stock price will do in the future so if you look at from a static perspective I simply do buybacks whatever happens I think I am returning value to shareholders from a price earnings ratio the price earnings ratio of apple has constantly been between 10 and 20 over the past years but mostly closer to 10 so let's say it was 12 this means that the return on from earnings is a six percent apple cannot find better investments than a six percent yield out there so if they can reinvest that money at a six percent return from their own earnings when they invest in their own shares then that is much better than keeping that money in bonds for one percent or two percent and as they can borrow for one percent and wait for the tax breaks to bring their money back even better so they borrow for one percent invest for six percent and this is really a valuing buybacks is like investing you have to see okay where will the stock price go in the future is it a smart buyback or not the problem with apple is that the book value really doesn't matter because it is an asset light model the book value of apple is mostly in cash so it doesn't really matter because asset light models what matters are earnings if earnings drop to five dollars per share on a crisis on a recession on china on whatever price earnings ratio of 12 then the stock price would be what 60 if the stock price would fall to 60 times four five million shares then we are at the market cap of 300 million billion compare that to the 200 billion already spent then that would be that all the previous money that they spent would be destruction of value if the stock price never falls to such lows if it just keeps going up and up and up over the long term and the buybacks the money that they intend to spend even more the 100 billion the 50 billion per year and the 100 billion in cash through dividends and buybacks mostly buybacks keep the stock price up then this financial engineering exercise might might work out well but the key is that those earnings are there and keep being there and that's why you always like to buy do buybacks below book value like buffet or intrinsic value like buffet says so he thinks that up apple apples intrinsic value is above 200 so he thinks those buybacks are good if there is a crisis and the earnings drop then the stock price might be much lower if apple wouldn't be a long term forever business then the buybacks would actually destroy value below book value so it's really something that you cannot put in a model it's a thing of perception apples management thinks it's valuable shareholders think it's okay because there is the yield they don't pay taxes on dividends and the money is returned in a form but you have to sell stocks to get your money there so you pay capital gain taxes and things like that so it's really a gray gray area and i hope this helped you a little bit to understand at least the yield how buybacks work and then how it is a gray area and how in such cases as apple it is gray in some other cases like other companies that really depend on assets on book value it's pure it's clear like g e buying back stocks at 40 and i wrote an article on that so i can shit on them that was pure shareholder destruction plus other things that led to what has happened thank you for watching i hope this helps looking forward to the comments and i'll see you in the next video