What Stock Buybacks Mean to Investors

Also called a share repurchase program, stock buybacks are a way a company returns wealth to the shareholder by purchasing outstanding shares of its own stock. A stock buyback is generally conducted in one of two ways: buying shares in the open market over time or tendering an offer to existing shareholders to buy shares at a fixed price. Most commonly the company will repurchase shares of its stock through the open market. 

There are many reasons a company may wish to begin a stock buyback program. One may be that the company sees its shares as a real value opportunity and wishes to purchase them while they are cheap. Any major corporation can serve as a value investor just as you or I can. A company expecting its share price to rise may believe that the best use of its money is a major stock buyback.

Another reason companies buy back their shares is that buying back stock reduces the amount of shares on the open market and can help prevent a hostile takeover.

A third reason is to reduce the dilution of its shares that happens when new shares are created. Dilution can be caused by stock option plans, secondary offerings, convertible bonds or preferred shares, and they often increase the overall number of shares available and decrease the company's earnings per share growth over time.

Finally, a company may choose to implement a stock buyback program to cover up a poor performance. Investors use financial ratios to help make investment decisions, and a major stock buyback reduces the number of shares available, creating more attractive financial ratios. 

When a stock buyback occurs, most investors will not see any substantial change in their stock ownership levels or cash paid to them as they would through a stock split or a dividend increase, but there are subtle ways in which the investors are affected. Since a buyback reduces the overall number of shares available in the open market, in theory, your stock should be worth more money in the long run.

Another way in which the common shareholder can benefit is through the price support that a major stock repurchase plan will provide. For example, in a down market this kind of buyback will provide major support for the price of a stock and should help investors feel more secure about their positions.  

A corporation that buys back its shares may come in many different shapes and sizes, but there are some characteristics they generally share. First of all, a business that is buying back its stock should have a large amount of cash on its balance sheet. If the company does not have a large amount of cash and a good cash flow ratio, you have to wonder why it would be buying back stock in the first place. Additionally, companies that are more mature are more likely to buy back their own stock. A company that is in its infancy will likely be busy paying off its debt or investing in expanding its market share.

Whether a stock buyback means that the stock will appreciate in the coming months or years is certainly a disputed question. Through the years, buybacks have proved to be beneficial to a stock’s price in the short-term because the program generally draws investors to the shares. And that the company is making multiple large purchases will help the price of the stock. The part that is much less clear is the overall effect on the long-term returns of a stock. Over the long run there has not been any hard data to point to a direct correlation between a stock’s price movements and a stock buyback program. The bottom line is that a stock buyback will often help in the short run, but the long-term will typically be affected more by other catalysts.

Stock buybacks are a fairly common occurrence, although the condition of the overall market usually factors into just how much a corporation is willing to repurchase. For the average investor, one of the most frequent questions is: "Is the stock buyback program a positive or a negative for the stock I own?" Typically it's positive, but a more concrete answer can only be determined on a case by case basis.

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