UPDATED: April 2022
3 Reasons Why a Company Should Consider a Share Buyback – Share buybacks refer to the repurchase of shares or stocks by the company that issued them. A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors. With share buybacks, the company can directly purchase the stock on the open market or from its shareholders.
In recent decades, share buybacks have overtaken dividends as a preferred way to return cash to shareholders. Though smaller companies may also choose to exercise buybacks, blue-chip companies are much more likely to do so because of the cost involved.
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As companies raise equity capital by selling common and preferred shares, it may seem counter-intuitive that a business might choose to give that money back. However, there are numerous reasons why it may be beneficial for a company to repurchase its shares, including ownership consolidation, undervaluation, and boosting its key financial ratios. Here are some of the reasons why companies should consider a share buyback.
1. Unused Cash is Costly – Reasons to Buyback Stock
Each share of common stock represents a small stake in the issuing company’s ownership, including the right to vote on the company policy and financial decisions. Companies issue shares to raise equity capital to fund expansion, but if there are no potential growth opportunities in sight, holding on to all that unused equity funding means sharing ownership for no reason.
Businesses that have expanded to dominate their industries may find that there is little growth to be had. With so little headroom left to grow into, carrying large amounts of equity capital on the balance sheet becomes more of a burden than a blessing. Shareholders demand returns on their investments in the form of dividends, which is a cost of equity, so the business is essentially paying for the privilege of accessing funds it isn’t using.
Buying back some or all of the outstanding shares can be a simple way to pay off investors and reduce the overall cost of capital. This is just one of the 3 reasons why a company should consider a share buyback
2. Preserves the Stock Price – Reasons to Buyback Stock
The second of 3 reasons why a company should consider a share buyback. Shareholders usually want a steady stream of increasing dividends from the company, and one of the goals of company executives is to maximize shareholder wealth. However, company executives must balance appeasing shareholders with staying nimble if the economy dips into a recession.
One of the hardest-hit banks during the Great Recession was the Bank of America Corporation (BAC). Since then, the bank has recovered nicely but still has some work to do in getting back to its former glory. As of the end of 2017, Bank of America had bought back nearly 300 million shares over the prior 12-month period. Although the dividend had increased over the same period, the bank’s executive management had consistently allocated more cash to repurchases than dividends.
3. The Stock is Undervalued – Reasons to Buyback Stock
Another major motive for businesses to do buybacks is that they genuinely feel their shares are undervalued. Undervaluation occurs for many reasons, often due to investors’ inability to see past a business’s short-term performance, sensationalist news items, or a general bearish sentiment. A wave of share buybacks swept the United States in 2010 and 2011 when the economy underwent a promising recovery from the Great Recession.
Many companies began making optimistic forecasts for the coming years, but company stock prices still reflected the economic doldrums that plagued them in years prior. These companies invested in themselves by repurchasing shares, hoping to capitalize when share prices finally began to reflect new and improved economic realities.
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Buyback Analytics is a Top Tier Investing Platform to help investors find, analyze, and profit from investing opportunities not found through traditional investment tools. We specialize in this simple concept: Follow the trades of Insiders – CONSISTENTLY PROFITABLE Traders, Investors, and Institutions because THEY get Inside Information that YOU don’t:
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Stock Buybacks (Share Repurchases) by Public Corporations (ie. Apple, Tesla, Netflix, Meta (Facebook), Microsoft, etc.)
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