Stocks are units of ownership of a company. By buying back shares owned by investors, companies are, essentially, re-purchasing themselves. A stock buyback is often called a share buyback, share purchase authorization, or share repurchase. Stock buybacks have been on the rise in recent years: in 2022, stock buyback announcements reached a record $1.22 trillion. 

In this article, we’ll cover:

• How stock buybacks work
• Why companies buy back stock
• Implications of stock buybacks 

How do stock buybacks work?

Most of the time, companies repurchase stock from shareholders on the open market, at market value. A company performing a stock buyback will generally announce a “repurchase authorization” alongside how much money they’re allocating to buying shares or the percentage of total shares they’re looking to purchase. 

Investors are under no obligation to sell back their stock. The company buys from those who want to sell, just like any other investor would. These shares are then purchased and “removed” from the market, and that ownership is reabsorbed into the company. 

A company will generally use its own money to repurchase stock, but it could also borrow cash for a stock buyback, though it’s a higher risk. And, despite having an authorization in place, there’s always a chance that the company doesn’t go through with the buyback should other priorities arise. 

Why do companies buy back their stock?

Companies issue a stock buyback for several reasons, but the primary goal is to create value for shareholders by raising share prices and increasing the company’s value on paper. 

Stock prices are driven by supply and demand. By reducing the number of available shares (supply), companies increase demand. More demand can drive higher stock prices, boosting value for shareholders.

Stock buybacks also impact a company’s balance sheet. The shares the company buys back are either canceled or held in treasury, not counted as outstanding stock. Having fewer shares on the market increases the earnings per share (EPS) and the price-to-earnings ratio (P/E ratio). Both are data points that help investors understand a company’s value and performance. 

Beyond simple valuation, stock buybacks offer companies several additional benefits.

• Consolidate ownership: A stock represents partial ownership in a company and usually comes with voting rights and claims to capital. By issuing a stock buyback, a company reduces the total number of owners with these rights. 
• Boost share prices: If a company feels that its shares are undervalued, it may repurchase stock to increase demand and boost investor confidence. If a company is worth the same amount as before but split into fewer pieces, each remaining shareholder now has a bigger piece of the pie. 
• Attract more investors: Stock buybacks can be seen as a sign of management confidence in future performance. After all, why would a company buy back stock they expect to decrease in value? This display of optimism can attract future investors.
• Increase flexibility: Stock buybacks are a more flexible way to return cash to shareholders than paying dividends. Dividends are paid on an ongoing basis,  and they’re a long-term strategy for providing shareholder value. Stock buybacks, on the other hand, are one-offs, so they’re easier for companies to control.

Is a stock buyback a good thing?

Stock buybacks can be a good thing, but they can also come with drawbacks for companies, employees, and investors if mismanaged. 

Is a stock buyback good for companies?

Stock buybacks allow companies to consolidate ownership, increase a stock’s demand, and possibly improve their valuation. By buying back shares, the company is paying off investors and reducing the overall cost of capital, especially if they offer dividends. On paper, a buyback often looks like a good idea. 

When mismanaged, a stock buyback can backfire for the company. By spending money on a buyback, a company isn’t investing in other ways that could improve the business or increase efficiency. The improved EPS and P/E ratio is just on paper, and the increase is often temporary or inflated. It can make a company’s earning potential appear better than it actually is. And if a company borrows money for a stock buyback, there’s always the risk that the debt could negatively affect their finances down the road. 

Is a stock buyback good for employees?

Stock buybacks could be good or bad for employees depending on the company, its financial situation, and how they provide benefits to their employees. When stock is a part of total compensation, employees of public companies often own a fair amount of their company’s stock. Because they are both investors and employees, they can benefit when a company buys back their stock at a good value, whether they sell or hold onto their stock at a higher price.

But stock buybacks mean that companies are investing money in the buyback that they could theoretically use elsewhere in their budget, like for employee compensation or reinvestment in the business. If the company is using a stock buyback to artificially bump up a company’s earnings, it could negatively impact employees. 

Is a stock buyback good for investors?

Just like employees and companies, stock buybacks can be good or bad for investors. It all comes down to whether the increased stock value is meaningful or artificial and temporary. 

In the short term, investors will see an increase in stock prices because the total number of available stocks has decreased. But that doesn’t necessarily mean that the company is performing any better than before. The money companies are reinvesting in their stock could be used to grow or increase efficiencies. There’s also a chance that the increase in share value could be temporary if the buyback is artificially inflating prices.  

Additionally, many companies provide stock to executives as part of their compensation. In some cases, company leaders might use a buyback to temporarily boost share prices in order to secure a bigger gain on their stock options. This may not necessarily be in the best interests of other shareholders. 

Investors should look at the company’s performance, any available plans, and the results of past buybacks when deciding whether to sell or hold onto their stock. If the company is buying at a premium price and you believe the company is continuing to work toward improving shareholder value, it may make sense to stay invested. If you believe the share price is overvalued or you don’t have confidence in the company’s future growth, a stock buyback may be an opportunity to sell.

Start participating in the stock market

A stock buyback only affects investors who already own shares in the company. You may or may not encounter a buyback as an investor, but it’s good to be prepared by understanding how stock buybacks work. In fact, getting to know key investing terminology can come in handy no matter where you are in your investing journey. With a focus on investing for the long term and keeping yourself educated, you can pursue a strategy that makes sense for your financial goals. 

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The post What Is a Stock Buyback? appeared first on Stash Learn.

A buyback means that the company purchases a large amount of its own shares from existing investors. By doing that, it hopes to increase the value of its remaining shares in the market by decreasing the supply, potentially rewarding existing shareholders with a higher stock price.

There are a number of ways that companies can buy back their own shares. 

One quick way is through what’s known as a tender offer. In this scenario, the company can potentially buy back its own shares by setting a fixed price, and then “tendering” that offer to existing shareholders. Often that offer will be at a premium to the existing stock price–meaning the company will offer to purchase shares at a higher price than the current price of shares on the market, which serves as an incentive for investors to sell. Investors then have the option to either accept or reject the offer.

But there’s another type of tender offer, called a Dutch auction tender offer. (The name comes from the Dutch tulip market of the 17th century, where the tactic appears to have originated.)

Here’s how a Dutch auction tender offer works. A company will decide to purchase a set dollar amount of shares from existing investors. But instead of setting a fixed price, it will set a range. Investors can then bid on the range of prices to sell their shares. 

Here’s the thing. Investors are not guaranteed a sale at the highest price—or any price for that matter. The company can’t exceed the total dollar amount it set for the share repurchase. The company will typically multiply the number of shares offered at the lowest price, and if the total dollar amount for the share repurchase isn’t met, it will jump up successively to the next highest bid prices to meet its threshold amount. Ultimately, investors will receive something close to the average between the highest and lowest bids.

How a Dutch auction tender offer works

It can get pretty complicated, but let’s look at a simplified example to help illustrate how a dutch tender offer works. 

Let’s say that a fictional company called ABC Widgets conducts a Dutch auction for $10 million worth of shares, and it sets a price range between $10 and $15 for each share. Let’s assume that investors offer 500,000 shares at $10. At that amount, it means ABC would only meet half its sale threshold, at $5 million. (500,000×10=5 million). Now let’s say that the next batch of investors offers 400,000 shares at $12.50, worth another $5 million (400,000X12.5= 5 million), bringing the amount to the $10 million it has allotted.  

ABC would end up purchasing those shares.  However, if other shareholders offered to sell their shares above $12.50, ABC would not buy those shares, as those shares would exceed its aggregate sale amount. 

ABC would essentially buy the shares at a weighted average price between the high and low ranges that meet its $10 million purchase price. (A weighted average is similar to an average, except that it weights some of the data points more heavily than others.)

Although the company will set its auction range at a premium, or higher than its existing share price, it can potentially save money on the share repurchase by buying some shares at the lower price, and others at higher prices. Investors have an incentive to sell by potentially benefiting from a sale at a higher price than the lowest one in the auction range.

Good to know:  Often, companies will create something called an odd-lots provision. That’s for investors who own very few shares, typically fewer than 100. The odd-lots provision ensures that all of the shares are purchased at the prevailing price following the auction.

Something else to think about: A company that conducts a Dutch auction tender offer will typically do so over a set period of time, generally between one to two months. It is not required to complete the offer, and can cancel it at any time.

Stash and Dutch Tender Auctions

Stash allows investors to purchase fractional shares. Fractional shares may not be purchased in some tender offers. Some tender offers have an odd-lots provision for holders of fewer than 100 shares, meaning your shares will be sold at the prevailing price.

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