A company’s treasury stock is any shares that have been previously issued by the company that are now held by the company itself, usually through share buybacks on the open market or through a structured repurchase scheme.
Treasury Stock Example
Suppose that a new company creates and publicly issues 1,000 shares at its inception at $10 per share.
In this case, the entirety of a company’s shares will be held by the public, and the treasury stock of the company will be 0.
The company then distributes some of its earnings as dividends and invests the rest in development.
After a decade, the company decides to repurchase 100 of its 1,000 outstanding shares using profits instead of investing in further development, as it believes its markets are now saturated with little room for future growth.
The treasury stock of the company is now 100 and there are 900 publicly-held shares of the company.
While the value of existing shares may drop as a result of the reduced potential for future earnings growth from a reduction in development investment, they may also rise as a result of all future earnings being distributed over a smaller pool of publicly-held shares.
After another year the company decides to retire the 100 shares held in its treasury stock, reducing the treasury stock of the company to 0, and leaving the number of publicly-held shares unchanged.
While this has no effect on dividends, the price of the shares may rise as a result of the decreased likelihood of future share issuance’s that would dilute the value of future earnings distributions.
Recommended Stock Investing Posts:
- Traditional IRA vs Roth IRA
- Best Trading Books
- Using Behavioral Finance to Your Investing Advantage
- Advantages of Investing in Small Cap Stocks
- PE Ratio Explained
- Teaching Children to Invest in Stocks
- Should Blue Chip Stocks Be Your First Investment
- The Neatest Little Guide to Stock Market Investing Review
Treasury Stock and the Balance Sheet
Treasury stock is held on the company books as equity.
Shares held as treasury stock do not receive dividends, which can have a pronounced effect on company valuation. The smaller the number of shares that are privately held, the greater the amount of earnings that can be distributed to each share.
Treasury stock also loses its voting rights, which means that company management cannot use shares held by the company to influence company policy at a board level or appoint directors to the board. This is an extremely important factor in how companies are managed.
Finally, treasury stock held on the balance sheet can be re-issued in the future without the need for any additional legal restructuring.
The shares held as treasury stock can be resold directly on the market or distributed through some other means without the complex process involved in the creation and issuance of new shares.
Shares held as treasury stock can also be formally retired, which means that they lose all value and legal significance, and effectively cease to exist.
Trading and Treasury Stock
Treasury stock is important to company valuation in a number of different ways. Day traders who incorporate fundamental analysis into their strategies, particularly research based on balance sheets, will often encounter treasury stock in the process.
Not only can treasury stock influence the long term price of a company’s shares, it can also influence their value in the short term when a company uses their treasury stock in one or more ways.
Likely the greatest influence of treasury stock on the value of a company’s shares is the impact on the company earnings on dividends.
Any shares that are taken out of public circulation and held as treasury stock no longer receive dividend payments, which shrinks the pool of shares that must divide any earnings disbursements.
Companies that perform share buybacks often see a sharp increase in the value of their shares as the expected value of future dividends rise.
However, the converse effect is that a large treasury stock may make some investors wary, as these shares can be quickly reissued to the public without the lengthy and complex process involved in issuing new shares, which can lead to a dramatic drop in the value of the shares that are currently held by the public.
A company’s treasury stock will be important to day traders who are experienced in balance sheet analysis.
These sorts of corporate finance structuring issues, such as a company’s treasury stock, can often have dramatic impacts on a company’s share and bond prices, so day traders with experience in balance sheet analysis are well-positioned to profit from changes in a company’s treasury stock.