When you own a share of stock, you own a portion of the company. Therefore, when a company makes an initial profit, and the money in their bank accounts increases, the company increases in value. As a shareholder, that money is already yours, even though it is not in your account.
Let’s look at it from the perspective of a person who owns 100% of his company, Acme Chemical. Let’s say they make a $5 million dollar profit this year. The owner can do whatever he wants with the money: re-invest the money in the company, pay himself a dividend, or buy another company. No matter what our owner does with the money next, he is already $5 million richer. The money has been his since the day it made its way into the company’s bank account. Therefore, the choice of what to do with that money should depend only on what the best investment is. If there are no good investments (either inside or outside the company), the owner can pay himself a nice dividend and take a vacation.
So think of Acme when you read about a dividend or a stock buyback. As a part-owner of a company, you were richer once the company made a profit. What the company should do with the money once it has it depends only on what the best investment is. If the company’s stock is cheap, a buyback is a good investment. If the company can expand profitably, then re-investment in the company is a good course. If competitors are for sale cheap, then an acquisition could be good. If nothing else seems good, smart management will pay a dividend.
If, however, a company spends its profits on buybacks of expensive stocks or overpriced acquisitions, then management is being stupid. That is a good time for smart value investors to sell.