If you are familiar with the world of stock market investing, you may have come across the concept of stock buybacks from time to time. If you are wondering what stock buybacks are in the first place, it involves a company buying back its own shares from the shareholders. So, the company which has issued shares before pays a portion of shareholders to absorb ownership back again.
But why do companies buy back shares?
Companies could do this for several reasons. Here are some of them:
– Buying back shares helps a company consolidate its ownership.
– Sometimes, companies may have plenty of cash at hand and not many projects it is interested in investing. A company may not choose to have a lot of cash shown in the books and therefore buyback shares.
– Share buybacks boost a company’s earnings per share or EPS.
– Companies choose to buy back shares because it helps them beat any chance of takeover or acquisitions by other parties.
However, are share buybacks good?
The answer to the question, “are buybacks good?” is both yes and no, depending on the situation. To address the question, why are stock buybacks good, here are some answers:
When the share numbers come down owing to a buyback, the EPS goes up. Because the company shells out cash to buy back the stock, the cash shown in the books comes down and boosts the return on equity or RoE. So the answer to the question, “are share buybacks good?” in such a scenario would be a yes. Share buybacks are good when the company’s management perceives that their shares may have been undervalued. Share buybacks also instill confidence among investors as it is seen as boosting share value and is a good signal for shareholders.
From the shareholder’s point of view, share buyback offers the advantage of flexibility wherein they can optimise the benefits. If a shareholder wants to exit a stock, they can use the opportunity of buyback to do so at a premium. For the remaining shareholders, it is beneficial as the value of the stock goes up and it also means the company has the will and the capacity to shell out cash and cares for the health of the firm.
When buybacks may not seem like the best option
Are buybacks good under all circumstances? There are certain scenarios where buybacks may not be a good thing and one must be mindful of these.
– Valuation of shares: Buybacks may not be good when there is overvaluation of shares. A good assessment of share worth helps. If a company buys back shares for more than they are worth, it signals that the decision making is on shaky ground and the investment is not a good one. When companies buy stock that is overvalued it also impacts value for shareholders.
– Borrowings involved: When buybacks are carried out by raising funds/borrowing, there is a risk involved. This is because the debt would have to be paid back at a certain juncture and there is always the risk of the company getting into financial trouble because of what it owes.
– Not quite the true picture: Yet another disadvantage could be that although share buybacks could boost factors like return on equity or earnings per share, these increases are not necessarily because of an increase in the company’s profitability.
Keep in mind these factors when looking at accepting a buyback:
As a shareholder, you may need to keep in mind certain factors when you want to take up a buyback of shares offer.
One of the factors to take note of include the buyback price on offer, as a shareholder. That way, a shareholder is able to decide whether the buyback offer is advantageous. It is also important to keep in mind the premium, which is the difference between the buyback price set for a share and the share price set at the time of the first offer. The share buyback size is yet another factor to note as it indicates how much cash the company is alright with parting.
Having taken note of the disadvantages, it needs to be said that the answer to the question, are stock buybacks good is a yes. Stock buybacks when done with all the scenarios carefully assessed, are indeed a positive signal for both the shareholders and the company. Shareholders are given the option of selling or holding the shares and that brings in a lot of flexibility. For the company, it is a chance to use its cash or avoid takeovers or acquisitions while also boosting the value of its shares.