When you think about buying shares in a company, you’ll want to look at its balance sheet. When you look at the balance sheet, you’ll find an entry under the shareholders’ equity section called treasury stock. The dollar amount of treasury stock on the balance sheet refers to the cost of shares that the company has issued and then repurchased later, either through a share buyback program or other means.
What Happens to Repurchased Shares?
Companies buy back their shares primarily to boost their stock price, among other reasons. When a company repurchases its shares, it can do several things with them. One option is to hold the repurchased shares and sell them to the public later to raise cash. They can also be used to acquire other companies.
The company can also cancel these shares, permanently reducing the number of outstanding shares. This will result in each outstanding share representing a larger ownership stake in the company for investors. This means they will receive a larger portion of profits and distributions as calculated by both basic and diluted earnings per share.
The Good and the Bad of Stock Buybacks
There is no better option between the two choices mentioned above. Generally, either can be good if the stock distribution is managed well.
A real-world example of smart stock buybacks is Teledyne Technologies. The company’s founder and CEO, Henry Singleton, made very good use of treasury stock during his tenure. He increased the actual value of shares for long-term shareholders who continued to invest in the company. Singleton repurchased shares when the company’s stock was low-cost, and he generously issued them when he felt the shares were highly valued. These actions brought cash for spending on assets and beneficial projects.
Sometimes, treasury stock buyback plans can destroy value. This might happen if the company pays too much for its own shares or issues shares to cover acquisition costs when those shares are valued less.
Real-World Examples
One of the largest examples you’ll ever see of treasury stock on a balance sheet is Exxon Mobil Corp., one of the leading oil companies and a major product of John D. Rockefeller’s Standard Oil empire.
At the end of 2018, Exxon had an astonishing $225.553 billion in treasury stock on its records that was bought and not canceled.
Exxon Mobil follows a policy of returning excess cash flow to shareholders through a mix of dividends and stock buybacks while retaining shares with plans to use them again. Every decade or two, the company buys a major power station. Exxon pays for the deal in shares. It reduces the shareholders’ capital percentage by reselling those shares, then uses cash flow to buy those shares back, effectively eliminating dilution.
It’s profitable for all parties involved. Target company owners who want to keep investing don’t have to pay capital gains tax from the merger. Exxon Mobil ends up with what is economically equivalent to a full cash deal, and their ownership percentage is restored. Exxon uses cash flow from both historical and newly earned profits to rebuild its position in treasury stock.
The Future of Treasury Stock
From time to time, there are discussions in the finance industry about whether it is good or not to change the rules regarding how companies carry treasury stock on their balance sheet. Currently, treasury stock is carried at its historical cost.
Some believe that treasury stock should reflect the current market value of the company’s shares. In theory at least, the company could sell the stock in the open market at that price or use it to acquire other companies, effectively converting it back into cash or useful assets. This idea has not yet gained prevailing acceptance.
It establishes
Some states have a maximum limit on the treasury stock that a company can carry as a reduction in shareholders’ equity at any given time. Limits are imposed because this is a way to remove assets from the company by the shareholders, which may threaten the legal rights of creditors. At the same time, some states do not allow companies to carry treasury stock on the balance sheet at all. Instead, they must exclude the stock. For example, California does not support treasury stock, although some companies in the state have such stock.
Source: https://www.thebalancemoney.com/treasury-stock-on-the-balance-sheet-357297
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