What You Should Know About Share Repurchases

A share repurchase or a share buyback is the re-acquisition by a company of its own stock. There are a number of reasons why a company would want to buyback its shares and there are a number of advantages of this for the investor.

Even though it may be very unlikely for a company to reject offers to purchase its shares, there are situations where it can choose to buy back some of its shares from investors. This is known as a share repurchase.

As the name implies, a share repurchase or a share buyback is the re-acquisition by a company of its own stock.

In other words, the company can choose to return funds to its shareholders by buying back the shares off the company’s investors, thereby reducing the number of outstanding shares that it has on the stock market. There are a number of reasons for this.

The first is that it really just has excess cash at hand. Rather than have too much cash in its books, it can buy them back from investors. Just as the shares are bought in an open market, the repurchase also takes place in an open market.

For the investor, this can offer a form of confidence that even if things generally go out of hand in the company, it does not need for worry about cash flow problems at least.

This also signals that the company has more than enough money to funds its operations and growth strategies. It can thus be assumed that the company is more confident about its growth potential and does not need to rely on equity to make things happen.

This, however, can be seen from a negative standpoint. A company buying back its shares might mean that it really cannot think of anything better to do with the cash at its disposal and this can be seen as a lack of foresight.

A company might also buy back its shares if it believes that the share price is grossly undervalued. Companies can choose to buy back some of their shares and hold until the value is better or reflects the true worth of the company. They would then resell them in the open market.

Share repurchase allows them to invest in themselves by reducing the number of outstanding shares on the market.

For the investor, share repurchases mean a number of things and some of them are advantages. The first is that it can increase the earnings per share of the company. By repurchasing shares, these companies will be reducing the assets on their balance sheets.

They would also be increasing the return on assets. When they repurchase shares, they would consequently be reducing the amount of outstanding shares. With the same level of profits, the earnings per each share would rise.

In other words, each of investors shares become more valuable as the investor now has more equity even if the company hasn’t made any gains or experienced any growth in that period.

There are also challenges that come with share repurchase programs. For the company itself, a risk arises in terms of what price they buy back the shares back at. A buyback is a terrible idea if the company pays too high for its own stock.

Nothing is worth pay excessively for – whether you are an investor of the company or the company itself. Where the company’s shares are overpriced, paying their own funds for stocks that are higher than they are worth would be counterproductive.

There are also situations in which certain companies repurchase stocks solely to artificially increase the prices of shares.

Another challenge is that because of the sudden spike in value when share repurchases are announced, this would be beneficial to short term investors and not the long term investors. It can be discouraging for the long term investor and it can affect the company negatively because it negatively impacts its value.

Share repurchases might be great, but the investor needs to critique the reasons for it and how the decision affects him or her in the short term as well as the long term.

Written by Lawretta Egba.