Share Repurchase

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.

Also known as a share buyback, this action reduces the number of outstanding shares. Because this action decreases the supply of shares, investors often consider that buybacks will drive an increase in the share price. This assumes demand for the shares will not be diminished by the action.

Key Takeaways

  • 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.
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Stock Buyback/Repurchase

Understanding a Share Repurchase

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 a Share Repurchase

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.

Buybacks can raise the share price and make the financial statements appear stronger.

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.

Advantages and Disadvantages of a Share Repurchase

Advantages

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.

Disadvantages

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.

Also, a share repurchase can 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.

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