Free cash flow to equity ratio | The Investment Quadrant by The Fifth Person

Questions › Category: Financials Quadrant › Free cash flow to equity ratio

DL asked 1 year ago

hi,
wanted to understand why would a company have negative equity when the company spend its free cash flow on share buyback as mentioned under the free cash flow to equity ratio topic.
Is it because when cash is used for share buy back, it’s asset reduces, hence its equity reduces?
Also when equity reduces its bad for investors isn’t it? Because equity is what’s left behind for investors when the company goes bankrupt right? How can share buy back increases share holder value then? Hmm..
thanks in advance!

1 Answers

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Victor Chng answered 1 year ago

Hi DL,

If the company spend their FCF on share buyback which will cause an negative equity for the company, it is not a bad sign but rather a good sign. It means that the company can generate FCF without any equity.

DL replied 1 year ago

Hi Victor,
Thanks for replying.

When FCF is used for share buyback, total asset reduces on the balance sheet? Is that why equity turns negative?

Victor Chng replied 1 year ago

When the company share buyback, it will reduce their capital reserve which cause the equity to reduce or turn negative.

Here a more detail explanation – https://finance.zacks.com/buying-back-stock-affect-stockholders-equity-1875.html