What is a buyback?
A buyback, also known as a share buyback, is when a company buys its own outstanding shares to reduce the number of shares available on the open market.
Companies buy back stock for a variety of reasons, such as increasing the value of the remaining stock by reducing supply or preventing other shareholders from gaining a controlling stake.
- A buyback is when a company buys its own shares on the stock market.
- Buybacks reduce the number of shares outstanding, thereby inflating (positive) earnings per share and generally increasing the value of the stock.
- Share buybacks can demonstrate to investors that the business has enough cash for emergencies and the likelihood of economic hardship is low.
How does “repo” work?
Learn about repos
Buybacks allow companies to invest in themselves. Reducing the number of shares in the market increases the proportion of shares that investors own. A company may feel its stock is undervalued and buy back to provide returns to investors. And because the company is bullish on its current business, buybacks also boost the percentage of earnings that are allocated to shares. If the same price-to-earnings (P/E) ratio is maintained, this will boost the stock price.
Share buybacks reduce the number of existing shares, making each share more valuable in the company. Therefore, the earnings per share (EPS) of the stock will increase, while the price-to-earnings (P/E) ratio will decrease or the stock price will increase. Share buybacks show investors that the business has enough cash for emergencies and the likelihood of economic hardship is low.
Another reason to buy back is for compensation purposes. Companies often reward their employees and management with stock awards and stock options. To provide incentives and options, companies repurchase shares and issue them to employees and management. This helps avoid diluting existing shareholders.
Because share repurchases are made using the company’s retained earnings, the net economic impact to investors will be the same as if those retained earnings were paid out as shareholder dividends (tax considerations aside).
How repo works
There are two ways to repo:
- Shareholders may receive a tender offer where they can choose to submit or bid for all or part of their shares at a price above the current market price within a given time frame. This premium compensates investors for bidding on their shares rather than holding them.
- Companies repurchase stock on the open market over an extended period of time, and may even have an outlined stock repurchase program that buys stock at specific times or on a regular basis.
Companies can fund their buybacks by taking on debt, cash on hand, or cash flow from operations.
On March 9, 2022, Amazon’s board of directors approved a $10 billion buyback program, the largest in the company’s history.
An expanded share repurchase is an addition to a company’s existing share repurchase program. Expanding share buybacks accelerates a company’s share buyback program and causes its stock float to shrink faster. The market impact of expanding share repurchases depends on its size. Large, expanded buybacks could lead to higher stock prices.
The repurchase ratio considers repurchase dollars spent in the past year divided by the market value at the beginning of the repurchase period. The buyback ratio can compare the potential impact of buybacks by different companies. It’s also a good indicator of a company’s ability to return value to shareholders, as companies that engage in regular buybacks have historically outperformed the market.
A company’s share price underperforms that of its rivals, even though the company’s financials are healthy. To reward investors and provide them with a return, the company announced a stock repurchase program to buy back 10% of its outstanding shares at current market prices.
The company had $1 million in earnings and 1 million shares outstanding before the buyback, which equates to $1 in earnings per share (EPS). Trading at $20 per share, it trades at a price-to-earnings ratio of 20. Other things being equal, 100,000 shares will be repurchased for a new EPS of $1.11, or $1 million in earnings distributed among 900,000 shares. To maintain a price-to-earnings ratio of 20, shares would need to rise 11% to $22.22.
Criticism of buybacks
Share buybacks can give investors the impression that the company has no other profitable growth opportunities, which can be a problem for growth investors looking for revenue and profit growth. Companies are not obligated to repurchase shares due to changes in the market or the economy.
Buying back stock can put a business in peril if the economy is in a downturn or the company faces unresolved financial problems. Others claim that buybacks are sometimes used to artificially inflate share prices in the market, which can also lead to higher executive bonuses.
In 2018, buybacks by all U.S. companies exceeded this amount for the first time in history. Apple alone authorized $100 billion in buybacks in 2018.
Why is the company buying back?
Buybacks allow companies to invest in themselves. If a company believes its stock is undervalued, it may make buybacks to provide returns to investors. Share buybacks reduce the number of existing shares, making each share more valuable in the company. Another reason to buy back is for compensation purposes. Companies often reward employees and management with stock awards and stock options, and buybacks help avoid dilution for existing shareholders. Finally, buybacks can be a way to prevent other shareholders from gaining a controlling stake.
How is the repo done?
The company can make an offer to shareholders at a price higher than the current market price, and shareholders can choose to submit all or part of the shares within a given time frame. Alternatively, the company may have an outlined stock repurchase program that periodically buys stock on the open market at a specific time or over an extended period of time. Companies can fund their buybacks by taking on debt, cash on hand, or cash flow from operations.
What is a repo criticism?
Share buybacks can give investors the impression that the company has no other profitable growth opportunities, which can be a problem for growth investors looking for revenue and profit growth. Buybacks can put businesses in jeopardy if the economy declines or the company faces unresolved financial problems. Another criticism of buybacks is that they can be used to artificially inflate share prices in the market, which could also lead to higher executive bonuses.