Stock Buybacks: Why Do Companies Re-purchase Shares?

There are various valid reasons why a company may undergo stock buybacks, and they benefit both parties – the investors and the company itself. In short, both parties tend to gain benefits in this scenario. The company re-absorbs its shares from shareholders in the hope of better stock value in the future. At the same time, the shareholders get a decent profit per share when they sell them back to the company. Even if the shareholders don’t sell back, they still tend to gain a profit since the purpose of this hassle is to increase the share price.

Written by Kaloian Parchev

Last Updated: 25 June 2024

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While dividends are a great way to boost your financial aspects, stock buybacks may yield better value. Let’s dig deeper!

Understand Stock Buybacks First!

Before proceeding further, let me give you an overview of the Stock Buybacks and their concept.

One way for a public company to buy back its shares is with cash on the open market. This is one way for a company to give money back to owners, and it doesn’t need to run its business or make other investments.

When a company buys back its shares, it does so on the secondary market, where buyers can sell their shares.

Shareholders don’t have to sell their stock back to the company, and the buyback isn’t just for a certain group of holders—anyone can take part.

When a public company wants to buy back its shares, it usually says that the board of directors has approved a “re-purchase authorization.”

This document spells out how much money will be used to buy back shares and the total number of shares or total percentage of outstanding shares the company wants to buy back.

So, now you have a better idea about the stock buybacks.

Reasons for Stock Buybacks

Company stock buybacks are mostly done to benefit shareholders. Here, value signifies a rising share price.

When a company’s shares are in demand, their price rises. A corporation that buys its shares boosts demand and raises stock prices, providing value for all shareholders.

Although dividends are the most typical means to return capital to shareholders, stock buybacks have benefits:

Increase in the stock prices

Each share re-purchase program aims to raise the share price. The board may think the company’s shares are cheap, making them an attractive investment.

On the other hand, investors may view a buyback as a sign of management confidence. Why would a corporation buy back stock it expected to lose value?

More flexible than dividends

Any corporation that starts or raises a dividend must pay it long-term. Reducing or eliminating the dividend risks decreased share values and disgruntled investors. Since share buybacks are one-time, management has more flexibility.

Tax efficiency

Dividends are taxed as income, but rising share values are not. The corporation may charge capital gains taxes on owners who sell their shares, while those who don’t get a higher share value and no taxes.

Offset dilution

Growing companies may compete for talent. They dilute shareholders by issuing stock options to retain exemplary employees, which raises the company’s share count over time.

The most prominent Buybacks of 2024

Let’s look at some facts and figures around stock re-purchases announced by giant corporations in 2023.

• Apple Inc. (AAPL) announced a stock buyback of $90 billion, which amounted to a total of its 3.4% shares.
• Chevron Corp. (CVX) announced re-purchasing its 21.7% shares valued at $75 billion.
• Salesforce, Inc. (CRM) $20 billion, Applied Materials (AMAT) $10 billion, and United Parcel Service (UPS) $5 billion.

Stock Buybacks Reduce Costs

Stock buybacks may seem to affect the company’s finances instantly, but they also play a big part in cutting costs and increasing the value of shares for shareholders.

Increasing profit per share (EPS) is one of the main ways that stock buybacks cut costs. When a company buys back its shares, the total number of existing shares goes down. Because of this, the company’s profits are spread out over fewer shares, which makes EPS go up.

When EPS increases, the stock price usually increases, too, which is good for shareholders and could attract more buyers.

Stock buybacks can also help reduce dilution by lowering the number of shares still outstanding. When a business issues new shares, it lowers the stock stake of current shareholders because each share is worth less to the business.

By buying back shares, a business can make up for this loss of value and keep or even grow the ownership stake of current shareholders.

Also, compared to dividends, buying back shares can be a better way to return capital to owners while saving them money on taxes. Dividends are usually taxed at the individual level, but capital gains from stock buybacks are only taxed when shares are sold. This means that owners can put off paying taxes until later.

Stock Buybacks Consolidate Ownership

Stock buybacks allow a company to eliminate some of its owners. By lowering the number of shares still outstanding, management can reduce the number of owners they have to answer to. This sharing of assets makes it easier to make decisions and can lead to better business management.

Stock buybacks also raise important financial metrics like profits per share (EPS) and return on equity (ROE) by lowering the number used to calculate these metrics. This might make the company’s finances and profits look better, which could help it attract more buyers and raise its stock price.

But it’s important to remember that buybacks are also used to raise management pay. Companies can give more profits to senior bonuses and incentives if they reduce the number of shares still out there. These programs often depend on meeting financial goals linked to metrics like EPS and ROE.

Basically, stock buybacks not only reduce the number of shareholders, which increases ownership, but they also change executive pay and financial measures, which could affect how the company makes decisions and the value of its shares.

Stock Buybacks Preserve the Stock Price

Stock buybacks are an important way for companies to keep their stock prices high. By lowering the number of shares still available on the market, buybacks increase the demand for those shares, which can cause their value to rise. This demand-supply relationship can help keep the stock price stable or even raise it, which can be good for current owners and could bring in new ones.

Also, buying back shares shows investors are optimistic about the company’s success and future, which can make investors feel even better and help the stock price stay stable or go up.

When companies use their extra cash for buybacks instead of other investments, they want to maximize shareholder value. This can build trust among investors and help keep stock prices stable over the long run.

Cons of Stock Buybacks

For the better part of this article, I have discussed the good parts of the stock buybacks. Let’s see some of the bad ones:

• They could be used as a form of financial engineering to boost profit per share falsely.
• Buybacks can lower investments in growth and new ideas.
• There are risks in market timing when buybacks are done at prices that are too high.
• The money used for buybacks could be put towards payouts, which would benefit shareholders.
• Using debt to pay for buybacks can raise the risk of losing money.
• A lack of openness could make it hard to see why buyback choices are made.
• Timed buying programs may make people worry about market manipulation.
• You might miss out on long-term growth chances when you use money for buybacks.

FAQ

Is a Share Buyback a Good Thing?

Stock buybacks can be good for both investors and companies, as they can lead to higher income and value for shareholders.

Who Benefits from a Stock Buyback?

Stock buybacks can be good for both investors and the company because they can raise stock prices and boost the value of shares held by shareholders.

What Does a Stock Buyback Do Exactly?

A company buys back its shares from the market. This can lower the number of shares available, increase revenue per share, and possibly drive up stock prices.

Conclusion

Stock buybacks are a great strategy that companies adopt to gain on various ends. Still, they carry their fair share of risks.

They may help raise the share price, thus benefiting both the investors and the company. They also help reduce costs, are tax efficient, and are more flexible than dividends.

Finally, what do you think of stock buybacks? Do they interest you, or are you a careful investor?

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