Shares-Stock Buybacks
Stock
price appreciation and dividends are the two most common ways
of in which a company can return wealth to its shareholders. There are other
useful methods for companies to share their wealth with investors and one of those
methods is Share buybacks.
The Meaning of Buybacks
A
stock buyback, also known as a "share repurchase", is a company's
buying back its shares from the marketplace. You can think of a buyback as a
company investing in itself, or using its cash to buy its own shares. The idea
is simple: because a company can't act as its own shareholder, repurchased shares are
absorbed by the company, and the number of outstanding shares on the market is reduced. When this
happens, the relative ownership stake of each investor increases because there
are fewer
shares, or claims, on the earnings of the company.
shares, or claims, on the earnings of the company.
Typically, buybacks are carried out in one of
two ways:
Tender
Offer Shareholders may be presented with a tender
offer by the company to submit, or tender, a portion or all of their
shares within a certain time frame. The tender offer will stipulate both the
number of shares the company is looking to repurchase and the price range they
are willing to pay (almost always at a premium to the market price). When
investors take up the offer, they will state the number of shares they want to
tender along with the price they are willing to accept. Once the company has
received all of the offers, it will find the right mix to buy the shares at the
lowest cost.
Open Market The second alternative a company has is to buy
shares on the open market, just like an individual investor would, at the
market price. It is important to note, however, that when a company announces a
buyback it is usually perceived by the market as a positive thing, which often
causes the share price to shoot up.
The Motives of buyback
- A buyback is the best use of capital at a particular time and a buyback generally increases shareholder value.
- Another reason a company might pursue
a buyback is solely to improve its financial ratios.Share buybacks reduce
the number of shares outstanding. Once a company purchases its shares, it
often cancels them or keeps them as treasury shares and reduces the number of shares
outstanding, in the process.
- The buyback also helps to improve the
company's price-earnings ratio (P/E). The P/E ratio is one of the most well-known and
often-used measures of value. In other words, fewer shares + same earnings
= higher EPS!
The Rationale
Whether share buybacks are good? If a stock is undervalued and a buyback truly
represents the best possible investment for a company, the buyback - and its
effects - can be viewed as a positive sign for shareholders.
