What Happens When A Company Buys Back Stock
After a stock buyback, the share price of a company increases. This is so because the supply of shares has been reduced, which increases the price. This can be matched with static or increased demand for the shares, which also has an upward pressure on price. The increase is usually temporary and considered to be artificial as opposed to an accurate valuation of the company."}},"@type": "Question","name": "Do I Have To Sell My Shares in a Buyback?","acceptedAnswer": "@type": "Answer","text": "As a shareholder you are not required to sell your shares back to the company in a share buyback; the company cannot make you do so; however, companies do offer a premium over the market price of the share to entice investors to sell.","@type": "Question","name": "How Do Companies Pay for a Buyback?","acceptedAnswer": "@type": "Answer","text": "Companies can pay for a stock buyback through cash on hand or through debt financing (borrowing money). Companies will either buy their shares on the market or purchase shares from existing shareholders."]}]}] Investing Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All Simulator Login / Portfolio Trade Research My Games Leaderboard Economy Government Policy Monetary Policy Fiscal Policy View All Personal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All News Markets Companies Earnings Economy Crypto Personal Finance Government View All Reviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All Academy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All TradeSearchSearchPlease fill out this field.SearchSearchPlease fill out this field.InvestingInvesting Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All SimulatorSimulator Login / Portfolio Trade Research My Games Leaderboard EconomyEconomy Government Policy Monetary Policy Fiscal Policy View All Personal FinancePersonal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All NewsNews Markets Companies Earnings Economy Crypto Personal Finance Government View All ReviewsReviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All AcademyAcademy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All Financial Terms Newsletter About Us Follow Us Facebook Instagram LinkedIn TikTok Twitter YouTube Table of ContentsExpandTable of ContentsHow Buybacks WorkEmployee Stock CompensationSecondary OffersRetired SharesShare Buyback FAQsThe Bottom LineInvestingStocksWhat Happens When a Company Buys Back Shares?ByTroy Segal Full Bio LinkedIn Twitter Troy Segal is an editor and writer. She has 20+ years of experience covering personal finance, wealth management, and business news.Learn about our editorial policiesUpdated September 07, 2022Reviewed byJulius MansaFact checked bySuzanne Kvilhaug Fact checked bySuzanne KvilhaugFull BioSuzanne is a content marketer, writer, and fact-checker. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies for financial brands.Learn about our editorial policiesWhen a company performs a share buyback, it can do several things with those newly repurchased securities.
what happens when a company buys back stock
After a stock buyback, the share price of a company increases. This is so because the supply of shares has been reduced, which increases the price. This can be matched with static or increased demand for the shares, which also has an upward pressure on price. The increase is usually temporary and considered to be artificial as opposed to an accurate valuation of the company.
As a shareholder you are not required to sell your shares back to the company in a share buyback; the company cannot make you do so; however, companies do offer a premium over the market price of the share to entice investors to sell.
Companies can pay for a stock buyback through cash on hand or through debt financing (borrowing money). Companies will either buy their shares on the market or purchase shares from existing shareholders.
Dividends are the more well-known way that companies return capital to shareholders, but stock buybacks are equally important to understand. Buybacks are a large part of the profit-allocation strategies of many publicly traded companies. Here's a rundown of how stock buybacks work, why companies may choose to buy back shares, and the other important things to know about stock buybacks and what they mean to you as an investor.
Suppose a publicly traded wants to return some of its profits to investors. Instead of giving them cash, a company can choose to buy back shares of its own stock, effectively taking them out of circulation.
There are two main ways companies can choose to share some of its profits to investors. The most familiar method of distributing profits to investors is through dividends. However, stock buybacks can be just as important, if not even more so, for investors.
To be perfectly clear, buybacks and dividends aren't an either-or scenario. Companies can choose to do some combination of both buybacks and dividends, and many do exactly that. As one example, Wells Fargo returned a total of $25.8 billion of capital to shareholders in 2018. $17.9 billion of this was in the form of stock buybacks thanks to a huge buyback authorization currently in effect, while the other $7.9 billion was paid directly to investors as dividends.
When a company earns a profit, there are three main choices of what it can do with its money, aside from simply hanging on to it as cash. We've already mentioned two of them -- dividends and stock buybacks. In addition, companies can choose to use some (or even all) of their profits to reinvest into the business in an effort to fuel growth.
Think of it this way: If a company's management conducts an analysis and determines that each of its shares has an intrinsic value of $100, but is only trading for $80, it is creating $20 of instant value for shareholders with each share it chooses to buy back.
This is the reason why many companies have somewhat flexible buyback programs. You may hear something like "management may buy back up to $1 billion in shares over the next 12 months, if and when such buybacks are justified by market conditions." One of the more famous buyback plans of recent history is that of Berkshire Hathaway. In order to address CEO Warren Buffett's growing cash problem, it allows the company to buy back as much stock as it wants, provided that Buffett and Vice Chairman Charlie Munger both agree that it trades for a substantial discount to its intrinsic value.
The effect of a share buyback is that there will be fewer shares after the buyback is completed. This may sound like a very obvious statement -- after all, if a company has 1 million outstanding shares and buys back 50,000 of them, it will have 950,000 outstanding shares after the buyback is completed.
However, it's important to consider exactly what this means. After a buyback is completed, the company's profits will be spread out among fewer shares than before, which makes the company's earnings higher on a per-share basis.
Continuing with this example, let's say that a company's profits for a certain year was $5 million. If there were 1 million outstanding shares, this translates to earnings per share, or EPS, of $5.00. Now, if the company had bought back 50,000 of its shares throughout the year, the $5 million in profit would now be spread across 950,000 shares, which means that its earnings would be $5.26 per share. In other words, the company's EPS would be over 5% higher after the buyback, even though its overall profitability is the same.
This can also help make earnings growth look better over time. Let's say that this same company earned a total profit of $5.5 million the following year, a 10% increase from the $5 million it earned the year before. However, we'll also say that the company bought back another 40,000 shares, making its outstanding share count just 910,000 at the end of the year. Dividing $5.5 million by 910,000 shows EPS of $6.04 -- a 15% increase from the year before. Just 10% of this amount was actual profit growth, and the rest is simply because there are fewer shares to spread the profits across.
On the other hand, buybacks are a far less scrutinized form of returning capital. And there's often a considerable amount of flexibility built into a company's buyback plan. When times get tough and profits shrink, a company can simply decide to buy back fewer shares than it otherwise would. Investors may be a bit disappointed, but it's likely to pale in comparison to what would happen if a company was forced to slash its dividend. 041b061a72