When you are thinking about buying stocks in a company, you will want to look at its balance sheet. When you are looking over a balance sheet, you will run across an entry under the shareholders' equity section called treasury stock. The dollar amount of treasury stock shown on the balance sheet refers to the cost of the shares a firm has issued and then taken back at a later time, either through a share repurchase program or other means.
These shares may be re-issued in the future, unlike retired shares that no longer have value. If shares no longer have value, a company removes them from its balance sheet.
- Treasury stock is the cost of shares a company has bought back.
- When a firm buys back stock, it may resell them later to raise cash, use them in an acquisition, or retire the shares.
- Opinions differ on whether treasury stock should be carried on the balance sheet at historical cost or at the current market value.
What Happens to Buyback Stock
Companies buy back their stock to boost their share price, among other reasons. When the firm buys back its shares, there are a few things that can be done with them. One choice is to sit on those buyback shares and later resell them to the public to raise cash. They can also be used in the purchase of other firms.
The company could also retire those shares and reduce the active share count for good. This would cause each active share to represent a greater ownership stake in the firm for investors. This means they would get a bigger cut of the dividends and profits as tallied by basic and diluted EPS.
The Good and Bad of Share Buybacks
Neither course of action shown above is better than the other. For the most part, either route can be good if the allocation of stock is managed well.
A real-world example of wise share buybacks is that of Teledyne Technologies. The founder and CEO, Henry Singleton, used treasury stock very well during his tenure. He increased the true value of the stock for long-term owners who stuck with the firm. Singleton bought back stock when the shares of the company were low cost. He also issued it liberally when he felt the stock was overvalued. These actions brought in cash to spend on useful assets and projects.
Treasury stock buyback schemes can sometimes destroy value. This might happen if a firm pays too much for its own shares or issues shares to pay for acquisitions when those shares are undervalued.
Though not entirely related to treasury stock, one of the most famous ill-timed examples to come out of corporate America in recent years was a 2010 deal in which the former Kraft Foods, spun out of Philip Morris, acquired Cadbury PLC. Kraft sold undervalued stock to pay for its overvalued $19.6 billion acquisition.
One of the largest examples you'll ever see of treasury stock on a balance sheet is Exxon Mobil Corp., one of the few major oil firms and the main offspring of John D. Rockefeller's Standard Oil empire.
At the end of 2018, Exxon had a stunning $225.553 billion in treasury stock on the books that it had bought back but not canceled.
Exxon Mobil has a policy of giving back surplus cash flow to owners through a mixture of dividends and share buybacks and keeping the stock with plans to use it again. Every decade or two, it buys a major energy firm. Exxon pays for the deal with stock. It dilutes stockholders' ownership percentages by reselling those shares, then using cash flow to buy that stock back, undoing the dilution.
It's a win-win for all parties involved. The owners of the acquisition target those who want to stay invested and don't have to pay capital gains tax from the merger. The owners of Exxon Mobil end up with the economic equivalent of an all-cash deal, and their ownership percentage gets restored. Exxon uses the cash flow from its older and newly gained earnings streams to rebuild its treasury stock position.
The Future of Treasury Stock
From time to time, certain talks take place in the finance industry as to whether or not it would be a good idea to change the rules for how firms carry treasury stock on the balance sheet. At present, treasury stock is carried at historical cost.
Some think it should reflect the current market value of the firm's shares. At least, in theory, the firm could sell the shares on the open market for that price or use them to buy other firms, converting them back into cash or useful assets. This thinking has yet to prevail.
Some states limit the amount of treasury stock a firm can carry as a cut in shareholders' equity at any given time. Limits are placed because it is a way of taking assets out of the business by the people who own shares, which in turn may threaten the legal rights of creditors. At the same time, some states don't allow firms to carry treasury stock on the balance sheet at all. Instead, they must retire shares. California, for instance, does not support treasury stocks, though some firms in the state do have them.