Buyback

What Is a Stock Buyback?

When a publicly traded company repurchases outstanding shares of its own stock on the open market (or directly from existing shareholders), this is known as a stock buyback. When a stock buyback happens, two things happen immediately — the number of shares outstanding decreases, and the proportion of the company each share represents increases.
In other words, after a buyback happens, existing shareholders (expecting they didn't sell any of their own shares back to the company) suddenly have an increased stake in the business, both in terms of their percentage ownership and the weight of their voting rights. A stock buyback is often described as a company "investing in itself."

For what reason Do Companies Repurchase Shares?

Generally, companies repurchase shares when they have "extra" cash available that isn't already slated for other investments or operations. This is typically done for two reasons — to increase share value for investors and to reduce share dilution.

Because price is a product of supply and demand, reducing the supply of shares on the market ought to increase demand, which ought to, thusly, increase share price, subsequently delivering extra value to existing shareholders.
Because buybacks are known to increase share price, just the announcement of an upcoming buyback often drives shares up in price as investors scramble to buy in before the buyback.

When a company's employees exercise their stock options, more shares enter the market, making each existing share represent a smaller stake in the company. This effect is known as share dilution. Buybacks combat share dilution by removing shares from the market, which results in each remaining share representing a larger stake in the company.

What Are the Effects of a Stock Buyback?

Stock buybacks have a multitude of effects across several areas. They affect shares, shareholders, financial ratios, and the company itself.

On Stock Price

As mentioned above, stock buybacks ought to — in theory — drive stock price up because of multiple factors. In the first place, assuming that demand for shares remains the same, however fewer shares are available, shares ought to trade at higher prices due to their relative scarcity.
Second, since buybacks require valuable cash, companies for the most part conduct them when they aren't needing funds to pay off debt or finance important operations. Thus, a buyback should be visible as an indication of financial health and stability, which can make a stock more appealing to investors, further driving its price up.

On Financial Ratios

Return on Assets (ROA): Stock buybacks require cash, which is an asset. Since buybacks reduce cash, assets (the denominator in the ROA calculation) are reduced, resulting in a higher return on assets figure, which is typically viewed as a positive by the market.
Return on Equity (ROE): Because buybacks reduce the number of shares outstanding, a company's equity (AKA book value, the denominator in the ROE calculation) decreases, resulting in a higher return on equity figure, which is typically viewed as a positive by the market.
Earnings per Share (EPS): Reducing the number of shares outstanding additionally helps [earnings per share](/fundamental earnings-per-share), as the same earnings are divided among fewer shares. The higher a company's earnings, the more attractive its stock.
Price-to Earnings (P/E): Since buybacks increase EPS (the denominator in the P/E calculation), they decrease a company's price-to-earnings ratio. The lower a company's P/E ratio is compared to its competitors, the more attractive it typically is to value investors.

On Shareholders

Since buybacks reduce the number of shares a company has in circulation, each remaining share represents a larger stake (and more voting rights) in the company. This is a plus for shareholders, as the more of a company they own, the more upside they will see on the off chance that the company increases in value. Furthermore, each share will have a larger impact in terms of its holder's voting rights when it comes to decisions that could affect a company's future success.
Further, since buybacks typically drive share price up, existing shareholders stand to benefit from these repurchases as capital gains.

On the Company

When a company conducts a buyback, it spends cash that might have been used for quite a few other purposes, including paying down debt, hiring, research and development, or the acquisition of new plants, property, or equipment. In other words, its assets decrease.
However, buybacks can likewise stir up publicity, impart public confidence in a company, and cause its stock to rise in value, which can help it secure extra financing and new investors.

Features

A repurchase reduces the number of shares outstanding, thereby blowing up (positive) earnings per share and, often, the value of the stock.
A buyback is when a corporation purchases its own shares in the stock market.
A share repurchase can demonstrate to investors that the business has sufficient cash set aside for emergencies and a low probability of economic troubles.

FAQ

What Are Criticisms of Buybacks?

A share buyback can give investors the impression that the corporation does not have other profitable opportunities for growth, which is an issue for growth investors searching for revenue and profit increases. Buybacks can put a business in a precarious situation in the event that the economy takes a downturn or the corporation faces financial issues it can't cover. Another analysis of a buyback is that it tends to be used to inflate share price falsely in the market, which can likewise lead to higher executive bonuses.

How could Companies Do Buybacks?

A buyback allows companies to invest in themselves. In the event that a company feels that its shares are undervalued, it might do a buyback to provide investors with a return. The share repurchase reduces the number of existing shares, making each worth a greater percentage of the corporation. Another reason for a buyback is for compensation purposes. Companies often award their employees and management with stock rewards and stock options and a buyback helps stay away from the dilution of existing shareholders. At long last, a buyback can be a method for preventing other shareholders from taking a controlling stake.

How Is a Buyback Done?

A company can make a tender offer, at a premium over the current market price, to shareholders where they have the option to present all or a portion of their shares inside a given time frame. Alternatively, a company might have an outlined share repurchase program that purchases shares on the open market at certain times or at regular intervals over an extended period of time. A company can fund its buyback by assuming debt, with cash close by, or with the cash flow from operations.