UPDATED: March 2022
When Does It Benefit a Company to Buyback Outstanding Shares? – When a company announces a share buyback program, they are officially signalling their intention to buy back some of their outstanding shares issued to raise capital. Shareholders are paid the market value of their stocks at the time of repurchase in exchange for periodic dividends and giving up their ownership in the company.
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There are several reasons why it makes perfect sense for a company to repurchase its outstanding shares. Repurchasing shares helps a company reduce their cost of capital, consolidate ownership, benefit from undervaluation of their stock temporarily, and free up profits for paying executive bonuses and inflating financial metrics. We will look at when purchasing outstanding shares that will benefit a company right here.
A buyback program isn’t initiated by the company when it feels that it doesn’t have any further use of equity funding. The company can use buybacks strategically to generate more equity capital and not issue any additional shares. If the company decides that its stock is undervalued, it can buy back all or some of the outstanding shares at a reduced price and wait till the market corrects itself.
When the stock prices increase again, the company can reissue the shares at the new price, which increases the equity capital and keeps the outstanding shares at a stable number.
The company also uses share buybacks to consolidate its ownership. Every share represents an ownership stake in the business, and when the company has fewer outstanding shares, they have fewer people they must answer to. When there are fewer outstanding shares, a company can inflate its financial metrics, which investors and analysts use to assess the business’s growth potential and value.
The earnings per share (EPS) ratio increases automatically, and the return on equity (ROE) also rises when profits remain stable and shareholder equity decreases. Even though it makes sense that a company would try to ensure its control remains in the core leadership’s hands, share buybacks are generally used to increase compensation for executives. The company’s net profit is used to pay out shareholder dividends, and when there are fewer shareholders, the profit is divided into fewer parts. This distribution makes the company look more profitable to outside investors.
Reducing Cost of Equity Financing
A business will consider a share buyback when they no longer require any use for equity funding. So, instead of dealing with the unneeded equity and the dividend payments that go with it, the company decides to refund the shareholders’ investment by reducing the average capital cost. However, equity capital and debt are used for funding growth.
When a business decides to refund equity capital, that shows there are no profitable expansion projects left to invest in. A blue-chip company, which is already dominating its industry will repurchase shares as there is no room left for growth.
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Stock Buybacks (Share Repurchases) by Public Corporations (ie. Apple, Tesla, Netflix, Meta (Facebook), Microsoft, etc.)
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