When analyzing a balance sheet, you're likely to run across an entry under the shareholders’ equity section called treasury stock. The dollar amount of treasury stock recorded on the balance sheet refers to the cost of the shares a company has issued and subsequently reacquired, 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, and which the company removes from its balance sheet altogether.
- Treasury stock is the cost of shares a company has reacquired.
- When a company buys back stock, it may resell them later to raise cash, use them in an acquisition, or retire the shares.
- There’s some discussion around whether treasury stock should be carried on the balance sheet at historical cost or at the current market value.
What Happens to Repurchased Stock
Companies buy back their stock to boost their share price, among other objectives. When the company buys back its shares, it has a choice to either sit on those reacquired shares and later resell them to the public to raise cash, or use them in an acquisition to buy competitors or other businesses.
Alternately, the company could retire those shares and reduce the overall outstanding share count permanently, causing each remaining share to represent a greater percentage ownership stake in the firm for investors—including a bigger cut of the dividends and profits as calculated by basic and diluted EPS.
The Good and Bad of Share Repurchases
Neither course of action mentioned above is necessarily better than the other as it depends entirely upon the capital allocation skill of management.
A real-world example such as conglomerate Teledyne in the hands of its founder and CEO, Henry Singleton, used treasury stock very well, increasing intrinsic value for long-term owners who stuck with the enterprise. Singleton bought back stock aggressively when the shares of the company were inexpensive, and issued it liberally when he felt the stock was overvalued, bringing in cash to spend on more productive assets.
Treasury stock repurchase strategies can sometimes destroy value, as companies pay too much for their own shares or issue 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, and issued 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 companies and the primary descendant of John D. Rockefeller's Standard Oil empire.
At the end of 2018, the company had a staggering $225.553 billion in treasury stock on the books that it has repurchased, but has not canceled.
Exxon Mobil has a policy of returning surplus cash flow to owners through a mixture of dividends and share repurchases, then keeping the stock with plans to use it again. Every decade or two, it buys a major energy company, paying for the deal with stock, diluting 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 everyone involved because the owners of the acquisition target who want to stay invested don't have to pay capital gains tax from the merger, while the owners of Exxon Mobil end up with the effective economic equivalent of an all-cash deal, their ownership percentage eventually restored as the oil and natural gas titan uses the cash flow from its established and newly acquired earnings streams to rebuild its treasury stock position.
The Future of Treasury Stock
From time to time, certain conversations take place in the accounting industry as to whether or not it would be a good idea to change the rules for how companies 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 company's shares. Theoretically, the company could sell the shares on the open market for that price, or use them to buy other firms, converting them back into cash or productive assets. This thinking has yet to prevail.
Some states limit the amount of treasury stock a corporation can carry as a reduction in shareholders’ equity at any given time. That's because it is a way of taking resources out of the business by the owners/shareholders, which in turn, may jeopardize the legal rights of creditors. At the same time, some states don't allow companies to carry treasury stock on the balance sheet at all, instead requiring them to retire shares. California, meanwhile, does not recognize treasury stocks.