What Is a Share Repurchase?
A share repurchase is a transaction whereby a company buys back its own shares from the marketplace. A company might buy back its shares because management considers them undervalued. The company buys shares directly from the market or offers its shareholders the option of tendering their shares directly to the company at a fixed price.
Repurchases reduce the number of outstanding shares, which is something that investors often feel will drive up share prices. This assumes demand for the shares will not be diminished by the action.
- A share repurchase or buyback is a decision by a company to buy back its own shares from the marketplace.
- A company might buy back its shares to boost the value of the stock and to improve the financial statements.
- Companies tend to repurchase shares when they have cash on hand and the stock market is on an upswing.
- There is a risk that the stock price could fall after a share repurchase.
- Apple is one of the biggest repurchasers of its stock.
How Share Repurchases Work
Share repurchases take place when companies decide to buy back their stock. Companies that repurchase their stock from the open market or directly from investors. Also known as a share buyback, it is commonly done to achieve:
- An increase in equity value
- A boost in the company's financial position
Because a share repurchase reduces the number of shares outstanding, it increases earnings per share (EPS). A higher EPS elevates the market value of the remaining shares. After repurchase, the shares are canceled or held as treasury shares, so they are no longer held publicly and are not outstanding.
A share repurchase impacts a company's financial statements in various ways. A share repurchase reduces a company's available cash, which is then reflected on the balance sheet as a reduction by the amount the company spent on the buyback.
At the same time, the share repurchase reduces shareholders' equity by the same amount on the liabilities side of the balance sheet. Investors interested in finding out how much a company has spent on share repurchases can find the information in their quarterly earnings reports.
Reasons for Share Repurchases
A share repurchase reduces the total assets of the business so that its return on assets, return on equity, and other metrics improve when compared to not repurchasing shares. Reducing the number of shares means earnings per share (EPS) can grow more quickly as revenue and cash flow increase.
If the business pays out the same amount of total money to shareholders annually in dividends and the total number of shares decreases, each shareholder receives a larger annual dividend. If the corporation grows its earnings and its total dividend payout, decreasing the total number of shares further increases the dividend growth. Shareholders expect a corporation paying regular dividends will continue doing so.
In some cases, a buyback can hide a slightly declining net income. If the share repurchase reduces the shares outstanding to a greater extent than the fall in net income, the EPS will rise irrespective of the financial state of the business.
Share repurchases fill the gap between excess capital and dividends so that the business returns more to shareholders without locking into a pattern. For example, assume the corporation wants to return 75% of its earnings to shareholders and keep its dividend payout ratio at 50%. The company returns the other 25% in the form of share repurchases to complement the dividend.
New provisions were put into place to prevent companies from trying to boost their stock price to benefit corporate executives. The Inflation Reduction Act of 2022, which was signed by President Joe Biden on Aug. 16, 2022, includes an excise tax of 1% on share buybacks of $1 million or more made after Dec. 31, 2022. Any new public or employee stock issues will not count.
Advantages and Disadvantages of Share Repurchases
A share repurchase shows the corporation believes its shares are undervalued and is an efficient method of putting money back in shareholders’ pockets.
The share repurchase reduces the number of existing shares, making each worth a greater percentage of the corporation.
The stock’s EPS increases, which means the price-to-earnings ratio (P/E) will decrease, assuming the stock price remains the same. Mathematically, the value of the shares hasn’t changed, but the lower P/E ratio could make it appear that the share price represents a better value, thus making the stock more attractive to potential investors.
A criticism of buybacks is that they are often ill-timed. A company will buy back shares when it has plenty of cash or during a period of financial health for the company and the stock market.
The stock price of a company is likely to be high at such times, and the price might drop after a buyback. A drop in the stock price can imply that the company is not so healthy after all.
A share repurchase can also give investors the impression that the corporation does not have other profitable opportunities for growth, which is an issue for growth investors looking for revenue and profit increases. A corporation is not obligated to repurchase shares due to changes in the marketplace or economy.
Repurchasing shares puts a business in a precarious situation if the economy takes a downturn or the corporation faces financial obligations that it cannot meet.
Shows the company believes its shares are undervalued
increases share value because it reduces number of shares
Makes stock more attractive to potential investors
Can be ill-timed
May lead to drop in price, which means company isn't healthy
Market may believe the company doesn't have growth opportunities
Can create challenges during economic downturn
Real-World Example of a Share Repurchase
There are many examples of share repurchases or buybacks in the marketplace. Let's take a look at Apple (AAPL). According to a CNBC report, the company spent more than $467 billion in share buybacks since 2012. In fact, it was reportedly the biggest repurchaser of its own stock among all of the companies in the S&P 500 and spent the most among some of its peers. The company spent $85.5 billion to buy back its stock during the 2021 fiscal year. This was in addition to the $14.5 billion it spent on dividends during the same period.
Is there a Tax on Stock BuyBacks?
The Inflation Reduction Act (IRA) of 2022 introduced a 1% excise tax on share repurchases of over $1 million, of any US corporation trading on an established exchange. The tax applies if more than $1 million of stock is purchased over the course of the tax year.
Which US Corporation had the Largest Buyback of 2022?
Apple (AAPL) at $21.7 Billion in stock buybacks in Q2 2022.
Do I Have to Sell my Shares During a Buyback?
No, you are not required to sell your share back to the company.
The Bottom Line
Corporations often buyback their shares. There are many reasons they will do this. There is debate about whether stock buybacks are the best use of a corporations excess capital. Like most other practices, there are pros and cons as this article has shown.