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Stock Buyback Reasons

What is stock buyback?

Companies issue stock in order to obtain resources for the financing of particular projects. However, they have the right to buy them back when they decide to under specific conditions.

This action is known as repurchase or also stock buyback. It represents the purchase of outstanding shares of company's stocks which are in the possession of the public and are out of the company's control.

Reasons for Stock Buybacks

Stock buyback may be good for some shareholders. On the other hand, it may be coverage for unbeneficial financial ratios. Here is a list of some of the reasons why a company may want to repurchase its stocks.

Reason 1

The company possesses a large sum of money and considers the stock buyback as a way of distributing it to its shareholders. Part of the money is distributed as dividends. Another way is by purchasing outstanding shares. The latter method is for the benefit of shareholders since even if they don't sell by the reduction in outstanding shares, they take advantage of this maneuver. 

Reason 2

The second reason is to temporarily increase the financial ratios of the company in the conditions of low ones. Since such ratios as EPS (earnings per share) and PE (price earnings) are based on the number of outstanding shares, the reduction in the number of shares will lead to better numbers in these ratios.

Reason 3

The third reason for buybacks is to alleviate employee stock option programs. In this way shareholder value will be increased and at the same time dilution will be reduced.

Reason 4

Stock buybacks can be used as a method of protection against takeovers from other companies. Since the stock buyback includes the repurchase of stocks from the open market, the takeover of an unfriendly competitor is made more difficult.

Having these reasons for executing stock buybacks, be aware of the exact reasons of your company when it announces the repurchase of stocks. If the price is right and this represents the most efficient use of money, then you will benefit from the stock buyback. However, if the intrinsic reasons of the company are the coverage of poor financial ratios or employee stock option plans, then be on the guard.

Ways to Execute Stock Buyback

In order to execute buyback, the company can follow one of the following ways:

  1. The company can offer the repurchase of shares to existing shareholders by offering them a fixed price that is above the current market price. The number of shares to be repurchased is fixed as well as the time period within which the repurchase will take place.
  2. The second way can be undertaken under the conditions of depressed stock prices. In this method, the company purchases its stocks directly from the open market. Again there is a time period within which the repurchase is executed.
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