If your interest lies in investment and building portfolios and you pick up any of the financial newspapers it is likely to say that you have heard or read some of the very common investing terms, out of which “stock buyback” is the one. So the question here lies is that what actually is Buying back shares and why do companies repurchase their own shares? Can a company gain more profit by buying its own shares? or what is the logic behind this whole phenomenon? Here are the most significant things to think about stock buybacks.
What is the Buying back shares?
In order to pay their investors, many of the companies are Buying back shares and this is known as buyback of shares or shares repurchase. During an initial public offering, a company tries to sell its own shares in the stock market, in that sense buyback is completely opposite to it. It is when a company offers to repurchase its shares from the already existing shareholders.
In the past few years, stock buybacks became very common. But it was not considered a solid thing to do in the 1990s. According to the S&P report provided by Harvard, not only the companies with huge names are investing in repurchasing their own stock the smaller businesses are also inspired by them. For example, SolarWind agreed to invest fifteen percent of its shares into stock buyback.
How do Buying back shares work?
In order to debate about what are the main aims behind stock buyback, it is essential to talk about how stock buybacks work? The talk around stock repurchase has more to do with how a company decides to use the cash. They have access to use it the way they want. The relatively high earnings, tax cuts and low rates of interest have all added to corporate cash stockpiles. When a company is flushed with cash it can use many other options to use it in the right way for example,
- Using its research and development programs
- Buying another company
- Getting its hands on new technology
- Making new buildings and branches
Returning money to its shareholders.
Which can then take the form of stock buybacks and dividends? In the past five years, it has been noticed that the top twenty companies have repurchased around $1.4 trillion shares with apple leading the way by far. As mentioned before, in-stock buyback a company buys its own shares from the shareholders which take them off the market, leaving very few shares outstanding. This technique changes the math on remaining shares in a key way.
The most common advantage of buying the company’s own shares is the increase in the EPS or Earnings per share. When the outstanding shares of a company decrease it leads to the rise in EPS. For example, if the net income of a company is $1000 and there are $100 outstanding shares, the EPS becomes $10, but if it has $90 shares the EPS rises to $11.1. It can be said that the higher the earning shares the higher the image of a company in the stock market.
Are there any benefits of Buying back shares?
The decrease in outstanding shares:
The first and very obvious benefit of the stock buyback is the increase in the stock’s price. When a company tends to buy back shares the numbers of outstanding shares decreases. And if the profitability of the company remains the same it helps the company to grow
There is good cash flow:
Buybacks can be a good reason for the company’s cash flow. If a company has access to wealth to buy back it’s own shares it can boost the investor’s confidence to invest in the company, which in turn can lead to more growth of the company. Of all the companies that initiated buybacks in the last years, the best performers were Apple, Disney, Intel, and Microsoft.
The wise use of cash:
Most of the time it happens that when a company has cash in abundance and there is no open door for the development, the money can be used by repurchasing the idle stocks and by doing so they can proficiently utilize money.
Decreases the chances of overtake:
Buyback shares also diminish the chances that another company can overtake the company, because of the increase in the promoter’s stake. It supports the price of stocks from reaching a very low level especially during the time when the market is facing some corrections.
Does buyback shares only benefit the company?
The answer to this question is no. Buyback shares do not only help the company to grow but it also helps the stakeholders and investors in a very positive way. Some of the benefits are mentioned below.
- When the company rebuys its own shares it buys them in premium which leads to the fact that the stock prices will also increase. The increase in the prices of stocks then helps the investors.
- As mentioned earlier by investing in buyback shares the outstanding shares of the company decreases and EP increases. This increase in the EP is also the favorite of investors and stakeholders.
Are there any disadvantages to buybacks?
For quite a long time, it imagines that stock buybacks were a totally positive thing for investors. Critics say that buybacks are a form of financial engineering that does nothing to improve business. And they can also provide cover for the poor financials and can mask greater problems to a company. As everything has it’s merits and demerits, sadly, but there are some disadvantages of buyback stocks. Some of them are mentioning below.
Low chances of company expansion:
Because the company invests an abundance of cash. Hence, when it comes to investing in repurchasing stocks. Then, very little cash is left for the opportunities to expand the company. Like research and development and buying other companies and because of this there remains very little room for the company growth. Henceforth organization isn’t utilizing that cash for some beneficial work. In concern of how the significance of stock buys have affecting the growth of companies. The CEO of BlackRock inc in an interview says, “It concerns us that, in the wake of the financial crisis. Many companies have shied away from investing in the future growth of their companies,”.
Investors might get trick:
The stakeholder and investors need to keep a check on the company’s past history before investing in it. At times it happens that an investor without any deep study of the company. Invests and expects much gain in the prices. Therefore financial specialists must check about the organization’s history. On the off chance that in past they have done something like this. Thus, at that point what were their aims and don’t get deceived.
No right planning in buying stocks:
It’s say that everything has it’s perfect timing and this is also correct. When it comes to buyback stock purchasing. Companies that are bad at investing in shares on time. End up paying more for the repurchase of shares. A company can face a huge fall if the timing is not right. For example, if an organization declares a buyback when stock costs are high. So, that would require a higher expense of capital.
Are share buybacks fortunate or unfortunate? As is so frequently the case in the account, the inquiry might not have an authoritative answer. After all this debate; One thing about buybacks is clear. That it is now a big part of the landscape of the finance world. In the view that some of the greatest technology giants have been investing. Their money in repurchasing their own stocks, for instance, Apple. We can surely say that it can bring some success to the company.