When a stock buyback is announced, it means the issuing company intends to repurchase some or all of the outstanding shares that were issued previously to raise equity capital. In exchange for giving up ownership stake in the company and periodic dividends, shareholders are paid the fair market value of the stock at the time of the buyback. A company may choose to buy back outstanding shares for a number of reasons. Repurchasing outstanding shares can help a business reduce its cost of capital, benefit from temporary undervaluation of the stock, consolidate ownership, inflate important financial metrics or free up profits to pay executive bonuses.

The most generous interpretation of a company buyback is that the business is doing quite well financially and no longer has need of so much equity funding. Instead of carrying the burden of unneeded equity and the dividend payments it requires, the company refunds shareholders' investment, reducing its average cost of capital. However, the purpose of debt and equity capital is to fund growth. So when a company voluntarily returns its equity capital, it may be an indication it has no viable expansion projects in which to invest. Blue-chip companies that have already come to dominate their industries may buy back shares because there is little room left for growth, rendering large capital reserves unnecessary.

A company buyback does not always signify the issuing company has run out of uses for equity funding. In fact, it can also be used as a strategic device aimed at generating more equity capital without issuing any additional shares. If the company feels its stock is undervalued, it can choose to repurchase some or all of the outstanding shares at the deflated price and wait for the market to correct. Once the stock price moves back up, the company can reissue the same number of shares at the new higher price, increasing total equity capital while keeping the number of shares outstanding stable.

Stock buybacks are also used as a means of consolidating ownership. Each share of stock represents a small ownership stake in the company. The fewer outstanding shares, the fewer people the business has to answer to; having fewer outstanding shares is also a simple way to inflate several important financial metrics used by analysts and investors to assess a business' value and growth potential. The earnings per share (EPS) ratio is automatically increased as its denominator is reduced. Similarly, the return on equity (ROE) figure gets a leg up if shareholder equity is minimized while profits remain stable.

While it may be understandable that a company would want to concentrate control of the business into the hands of its core leadership, the truth is that buybacks are increasingly utilized as a way to boost executive compensation. Shareholder dividends are paid out of a company's net profit. If there are fewer shareholders, the proverbial pie is divided into fewer pieces. In addition, many corporate bonus programs are predicated on the business attaining certain financial goals. Common benchmarks include increased EPS and ROE ratios, as mentioned above. Repurchasing outstanding shares enables businesses to increase executive compensation by making the company look more profitable.

  1. Why would I need to know how many outstanding shares the shareholders have?

    Find out why shareholders should know how many outstanding shares have been issued by a corporation, and learn what happens ... Read Answer >>
  2. What is the difference between authorized shares and outstanding shares?

    Calculating financial ratios can help investors understand a company's financial position, but only when a knowledge of various ... Read Answer >>
  3. What are the components of shareholder equity?

    Understanding company valuation figures, such as shareholder equity, is crucial in assessing a business. Read Answer >>
  4. How can a company buy back shares to fend off a hostile takeover?

    Learn about why a business might use a stock buyback to thwart a hostile takeover attempt by reducing its total assets and ... Read Answer >>
  5. How does a company's capitalization structure affect its profitability?

    Learn about capitalization structure and how the combination of debt and equity a company uses to fund operations can affect ... Read Answer >>
  6. What are the advantages of ordinary shares?

    Dividends and ownership rights are two advantages of investing in ordinary shares. Read Answer >>
Related Articles
  1. Managing Wealth

    4 Reasons Why Investors Like Buybacks

    Buybacks benefit investors by improving shareholder value, increasing share prices, and creating tax beneficial opportunities.
  2. Investing

    The impact of share repurchases

    Share repurchases can have a significant positive impact on an investor’s portfolio and are a great way to build investor wealth over time.
  3. Investing

    6 Bad Stock Buyback Scenarios

    Buying back shares can be a sensible way for companies to use extra cash. But in many cases, it's just a ploy to boost earnings.
  4. Investing

    Are Share Buybacks Propping Up the Market? (AAPL, MSFT)

    Companies are repurchasing their own shares at a rate not seen in nearly a decade, prompting observers to fret that demand for equities is not as strong as the past six weeks' rally would suggest.
  5. Investing

    How MasterCard Pulled Off a Buyback

    Stock buyback refers to publicly traded companies buying back their shares from shareholders. Why would they do that?
  6. Investing

    Stock Buyback Report: Was it a Smart Strategy in 2015? (AAPL, MSFT)

    Find out the story behind company stock buyback programs and how some of the larger stock buybacks of 2015 have fared for shareholders.
  7. Investing

    How Buybacks Warp The Price-To-Book Ratio

    Relying on price-to-book can get ugly if a company has repurchased stock. Learn why.
  8. Investing

    Why Buybacks Can Be a Waste of Cash (BX, BAC)

    Learn the motivations behind share repurchase programs, including how they can mask slowing organic growth and why many companies buy their shares high and sell low.
  9. Investing

    Behind U.S. Equities' Declining Buybacks and Dividend Payments

    Learn what a decline in share repurchases and dividend payouts by corporations means for equity markets, and whether it is a cause for long-term concern.
  10. Insurance

    The Share Buyback Report: The Financial Sector

    Examine historical buyback data from the financial sector to determine which quarters and companies contributed the most to repurchase activity.
  1. Buyback

    A buyback is a repurchase of outstanding shares by a company ...
  2. Share Repurchase

    A share repurchase is a program by which a company buys back ...
  3. Buyback Ratio

    Buyback ratio is amount of cash paid by a company for buying ...
  4. Earnings Per Share - EPS

    Earnings per share (EPS) is the portion of a company's profit ...
  5. Expanded Share Buyback

    An expanded share buyback is an increase in a company’s existing ...
  6. Leveraged Buyback

    A leveraged buyback is a corporate finance transaction that enables ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center