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 act reduces the number of outstanding shares, which increases both the demand for the shares and the price.
- 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 buyback.
What Happens After 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.
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), revenue and cash flow grow more quickly.
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.
Benefits of a Share Repurchase
A share repurchase shows that 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 while the price-to-earnings ratio (P/E) decreases or the stock price increases. A share repurchase demonstrates to investors that the business has sufficient cash set aside for emergencies and a low probability of economic troubles.
Between January 1 and February 1 of 2018, companies listed in the Standard & Poor’s 500-stock index announced buyback programs totaling $173 billion, which was the most significant amount of buybacks ever counted so early in a year, according to James Brumley, contributing writer to Kiplinger.
Drawbacks of a Share Repurchase
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.
To learn about the impact a share repurchase has, read; "The Impact of Share Repurchases."