How Share Buybacks Work

Understanding how share buybacks work for a company

Share buybacks, also known as share repurchases, occur when a company purchases its shares from the market to reduce the number of shares in circulation. It’s misunderstood by many investors, as they don’t know how share buybacks work and why a company would even need to initiate a buyback. They fail to understand that share buybacks can be extremely lucrative for a company when initiated for the right reasons.

They are designed to reward existing shareholders and provide them with more value for their money. When the number of shares in circulation drops, the price per share will increase, and that will mean shareholders will have more profits if they sell those shares in the market. This article will look at share buybacks, including their purpose and whether they are good news for investors.

What Are Share Buybacks?

When a company decides to repurchase its shares, it is known as a share repurchase or a share buyback. There may be several reasons why a company would opt to buy back its shares, which may include the following:

  • It feels the current shares are undervalued
  • It wants to reward existing shareholders
  • It wants to improve key metrics
  • It wants to increase share price

The number of shares in circulation decreases when a company buys back its shares, which will mean fewer shares in the market. The result is an increase in share value or price, and that will mean existing shareholders will have a chance to earn more profit if they sell those shares.

The most common reason for a share buyback is that the company feels its current shares are undervalued in the market. Therefore, it will buy back all of its shares in the market, which will create demand for the shares. When there are fewer shares in the market, it will raise the value of the shares even if it is temporary.

Are Share Repurchases Beneficial?

Share repurchases have been criticized by economists who claim that it is an artificial method for increasing share prices and an accounting trick used by CEOs to boost their earnings per share numbers. However, when done right, share repurchases can be incredibly beneficial to a company. It helps them reduce the number of shares in existence and ensures that the share price doesn’t drop below the margin the company has set.

Even though companies who engage in share buybacks are looked at with skepticism, they are only doing that to survive when you look at the bigger picture. They may be better suited to spend their money on hiring new talent or research and development, but share repurchases also provide them with a solution to their problems.