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ASK THE FOOL

Share-splitting math

Q: Does it benefit shareholders when companies buy back shares?

A: It certainly can, as the reduction in the share count leaves each remaining share with a bigger stake in the company. (Imagine a pizza being cut into seven instead of eight pieces — each piece will be bigger.) But the company should buy back shares only when they’re undervalued. If it buys back overvalued shares, it gets fewer shares for its money and destroys shareholder value. That money might have been better spent paying dividends or in some other way.

Here’s how buybacks work, in a simplified example: Imagine that Acme Explosives’ (ticker: KBOOM) earnings have stalled at $10 million annually, and it has 10 million shares outstanding. Its earnings per share (EPS) are thus $1. If Acme buys back a tenth of its shares, leaving 9 million, then its EPS suddenly rises to $1.11 ($10 million divided by 9 million).

When studying a company’s financials, it’s preferable to see earnings growing mostly due to business growth, not share buybacks. You can examine a company’s income statement for signs of buybacks — or look up news reports on them. Apple, for example, had 6.5 billion shares outstanding in 2013, and its recent share count was 4.9 billion. That reflects share buybacks.

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Q: If I buy shares of a stock after its “date of record” for a stock split, but before the actual split, will I get the additional shares?

A: Yes. As long as you’re holding the stock on the date of the split, your shares will be split — increasing in number and decreasing in share price proportionately. The record date is mainly for accounting purposes.

MY DUMBEST INVESTMENT

Hung up

Dear Fool: My dumbest investment was in the Finnish telecom Nokia. I read in a well-respected investment newsletter that the company would soon be closing a deal to sell equipment in Russia. But the market crash of 2008 sent Nokia shares down deep.

I kept hanging in there, but finally got disgusted and took the loss. It was too much of a hassle, waiting on a loser. I still wish them luck.

The Fool responds: Nokia was once a titan in the smartphone arena, boasting more than half the global market in 2007. By 2013, though, its share had dropped to 2 percent.

The 2008-2009 market crash was not its sole problem, though — its lunch was being eaten by Apple and Google’s Android system. While other companies’ stocks recovered after the market crash, Nokia’s stock kept dropping for some years.

Nokia is still a significant smartphone name, but it’s no longer making its own devices. It sold its smartphone business to HMD Global (a company run by former Nokia executives) and is licensing its name, which appears on the phones.

Never invest in a stock just because of rumors you’ve heard about it — and if it’s falling, be sure to do enough digging to find out whether its troubles seem temporary or lasting. Nokia still has believers today; they expect growth from deals with China-based companies and the rollout of new 5G networks.

THE MOTLEY FOOL TAKE

In your Face(book)

Many investors have been worried that Facebook’s (Nasdaq: FB) growth rate would hit a wall, but its latest earnings report instead showed signs of significant operating momentum. Its number of monthly active users jumped 11 percent year over year to over 2.2 billion people (!) in the second quarter of 2018; roughly two-thirds of those folks logged in to the service at least once a day. Facebook had no trouble monetizing all of that engagement, either, as advertising sales spiked 42 percent year over year to $13 billion.

Facebook’s average revenue per user has room to grow, and the company is still early in the game in exploiting the fast-growing online advertising industry. Importantly, it also owns other major social-media businesses, including WhatsApp and Instagram. Its media empire generates a gross profit margin of 83 percent and an operating profit margin of 44 percent.

Sure, the company’s expansion pace is slowing, as tends to happen with companies that grow huge. It’s also likely that its fat profit margins will shrink some as Facebook spends billions bulking up its data infrastructure and rolling out service improvements. But there’s no social-media business that can come close to claiming the community engagement Facebook has attracted, let alone its market-thumping earnings power.

With its core business looking healthy, this stock could be poised for strong long-term gains. (The Motley Fool owns shares of and has recommended Facebook.)