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What Happens When a Company Buys Back Stocks

18 Sep 2023

Introduction 

  • A buyback of shares is a decision of a company to repurchase some of its stocks or securities in the open market. 
  • This helps companies build their net worth and attracts potential investors. 
  • For many reasons, a company decides to buy back its shares. It can be to boost their stock value, improve financial statements, or when they need cash or when the market is up. 
  • When the company buys back stocks, it often gets allocated for retirement options, later secondary offerings, or employee compensation. Or the company reissued those stocks later on the stock exchanges. 
  • There are significant impacts of repurchasing the own stocks by a company. Let's explore some of these impacts in brief. 

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What are the impacts of share buyback? 

When a company buys back its stocks, it faces various impacts on different financial aspects. Following are some major areas where companies face significant effects due to share buyback. 

Earnings per share (EPS)

  • Repurchasing of shares leads to an increase in the ratio of EPS
  • This happens when the total number of outstanding shares reduces after repurchasing, but the net income remains unchanged. 

Financial statement

  • The share buyback is reflected in the company's cash flow statement under the head of financing activities and retained earnings. 
  • Along with the income statement, it also influences the company's financial statement. 
  • In the company’s Balance Sheet, the cash holding record gets reduced, lowering its total assets. This also leads to a reduction in shareholder’s equity.  
  • Such reductions often improve the performance metrics of stocks like Return on Asset (ROA) and Return on Equity (ROE). 

Portfolio of the company 

  • Share buyback sometimes positively affects the company by gaining the trust of investors and existing shareholders. The share buyback option is often seen confidently by investors and shareholders. 
  • This improves the company’s reputation in the market. This increases the share value of the company, enhancing its overall portfolio. 

Shareholders value 

  • Share buyback leads to an increase in EPS faster than any other operational improvements. 
  • This attracts investors looking for shares with steady EPS and enhanced growth potential. 
  • The buyback of shares from shareholders represents the company's positive image among potential investors. 
  • Investors see such a company as a grant market player with strong pricing power.

Bottom line

  • The share buyback increases the demand for the company’s shares and price by reducing the number of outstanding shares. 
  • The increase in share demand is temporary and often seen as an artificial valuation of the company. 
  • After a share buyback, the risk of a reduction in share price increases.  
  • The company can retire their buyback shares, hold them for future dates, or provide them to employees as compensation. 

 

Related Articles: What Is Statistical Arbitrage and How Does It Work | Difference Between FII And DII | What Are The Impacts Of Buyback On Share PriceSecured Vs Unsecured Bonds

 

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