Share buybacks and dilution
A share is a piece of a company. When the company buys back its own shares, every remaining piece gets bigger. When it issues new shares, every piece gets smaller – that is called dilution. As a shareholder, what counts for you is therefore not the company's profit, but profit per share.
The idea
Think of a company as a cake cut into pieces. Owning a share means owning a piece. If the cake is cut into fewer pieces, each piece is bigger – even though the cake itself stays the same. If it is cut into more pieces, each is smaller.
That is exactly what happens with buybacks and new shares. The value of the company does not automatically change, but your share of it does.
The formula
If profit stays the same and the number of shares falls, earnings per share rise. If the number of shares rises, they fall.
The worked example
A made-up company earns €500 million a year and has 100 million shares. Profit stays the same in all three cases:
| Case | Shares | Earnings per share |
|---|---|---|
| Today | 100 million | €5.00 |
| 10% bought back | 90 million | €5.56 (+11%) |
| 10% newly issued | 110 million | €4.55 (−9%) |
Without the company earning a single euro more, earnings per share rise by 11% through the buyback. New shares make them fall by 9%. If you only look at the whole company's profit, you see neither effect.
When a buyback is good
A buyback is an alternative to a dividend: the company returns money to its shareholders, just in a different way. Whether that is wise depends mainly on the price. If a company buys its own shares below their fair value, the remaining shareholders get more value than the company pays. If it buys too expensively, it gives money away to the shareholders who sell.
Warren Buffett has often described this: buybacks are good when the price is clearly below intrinsic value – and only with money the company cannot put to better use in its business.
Where dilution comes from
New shares arise mainly in three ways: in a capital increase, when a company needs fresh money; in acquisitions paid for with its own shares; and through stock-based pay for employees and management. The last is the least noticeable, because it happens a little every year.
So watch one simple number: how has the number of shares developed over ten years? If it falls, you own a bigger piece every year. If it rises year after year, your share quietly shrinks – even if the company is buying back shares at the same time.
Three common mistakes
What really belongs to you.
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Frequently asked questions
Is a buyback better than a dividend?
Not in principle. A buyback pays off mainly when the share is below its fair value. If it is above, a dividend is often the better way to return money.
How is this different from a stock split?
In a split, every share is divided into several, but every shareholder gets correspondingly more pieces. Your stake stays exactly the same. With dilution, new shares are created for others – your stake gets smaller.
Where do I see the number of shares?
In the annual report, usually as the average number of shares outstanding. What matters is the trend over many years, not a single figure.
Is stock-based pay always bad?
No. It can tie employees to the company's success. But it is real pay that shareholders bear through dilution. In valuation it should be treated like an expense.
Not investment advice. All content is for informational and educational purposes only. The company in the example is made up.