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The answer I've managed to find is that because ownership of the company is divided among fewer shares/people and thus the price of a share is higher. The thing is that this explanation neglects the fact that the company loses the money it used in the stock buyback which lowers the value of the company accordingly. Since you are redistributing the money designated for stock buybacks and the rest of the company among former stockholders the total value held by all former stockholders is constant so the only way the new stockholders can each hold higher value is if the former stockholders who are not new stockholders have less value than before.

I don't know much economics so I might be really wrong here.

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2 Answers 2

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  • as a result of buyback any future dividends per share will be higher. A simple model for price of stock is $P=\frac{D}{r-g}$ where P is price D expected dividend, r discount rate and g growth rate. If company buys half outstanding stock remaining stocks will get double the dividend they used to get before.
  • in more complex models value of a company depends on expected future performance. Companies can afford to buy back stocks only if they have good cash flow which can be interpreted as a signal that company is going to do well in the future.
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  • $\begingroup$ Companies usually don't have an aggregate dividend policy. Usually they have a dividend per share policy. Usually the dividend per share will not increase because there are fewer shares. $\endgroup$
    – H2ONaCl
    May 23, 2023 at 9:25
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    $\begingroup$ @H2ONaCl but higher earnings per share allow companies to pay out higher dividends. It’s not like dividend is fixed like coupon. When company buys back shares with same next year profit it can pay out higher dividends all else equal $\endgroup$
    – 1muflon1
    May 23, 2023 at 15:12
  • $\begingroup$ I agree that higher EPS means that they can probably afford to increase the div per share, all else constant, but my point is that it's not a certainty and it's not "automatic". Buybacks lead to higher EPS, all else constant. It's "automatic". Higher div per share only happens if the board decides to increase it. We don't know about a decision until it is made, so it's not certain. A steady rate of buybacks means EPS grows automatically every quarter. A dividend per share boost is more likely to be a once per year event and maybe not even then. $\endgroup$
    – H2ONaCl
    May 23, 2023 at 17:48
  • $\begingroup$ @H2ONaCl right, but the future expected profits and dividends are already priced in, so in counterfactual world where you halve share, price per share would rise up. Using widely accepted Neyman–Rubin framework, causal effects of actions are effects that would occur in counterfactual world where all parameters other than action are held constant, so in terms of causality there is causal effect from lowering number of shares to higher price. Of course other things can happen. If you drop a ball from tall building it might accidentally get intercepted by balloon, that is no reason to say gravity $\endgroup$
    – 1muflon1
    May 23, 2023 at 18:38
  • $\begingroup$ does not cause it to fall to the ground, just because when you do not hold other factors constant ball can actually ascend to the space due to factors that counteract the causal effect of gravity $\endgroup$
    – 1muflon1
    May 23, 2023 at 18:38
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Higher retained earnings, all else constant, implies a higher price per share. As you said, a buyback reduces retained earnings and reduces cash. This implies a lower price per share, all else constant.

The reason a stock price increase can be attributed to a buyback is because aggregate earnings divided by fewer shares results in higher earnings per share. If investors care about earnings per share then the price per share can increase.

Addendum...

Your title is "why do stock buybacks raise the price of stocks?". A suitable reply is that buybacks do not necessarily raise the price of a stock.

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