Public companies frequently buy back shares of their own stock. This may happen if company management believes that the company’s stock is undervalued. This is known as a stock buyback or share repurchase. A buyback can include purchasing shares from the stock market or making a tender offer to existing shareholders.
According to the Corporate Finance Institute, repurchased shares will either be retired or categorized as Treasury stock on the balance sheet. Treasury stock does not issue dividends or have voting power.
Should a Company Consider a Share Buyback?
Companies often implement share repurchase programs to preserve valuations when stock prices fall below specific market price thresholds. Companies may also use excess cash to repurchase their own shares to reduce liquidity. If the amount of a company's available stock exceeds the demand for those shares, the share price will drop.
Many companies offer stock grants and options to employees. To prevent a dilution effect on the market value of the shares, a company may buy back a number of outstanding shares. Stock repurchase can also serve as a means to protect a company against a hostile takeover.
Apple has a stock buyback program that shareholders find attractive by allowing the company to maintain a bullish market presence that inspires confidence among investors. Conversely, buybacks can also be a waste of money that can send the wrong signal to investors.
What Are the Advantages of Share Buybacks?
Company repurchases can boost the value of a company's shares by reducing the total number of shares available on the open market. This catalyzes higher prices and improves financial ratios. Morningstar reports that a buyback is often an alternative to dividend payments and raises values for employees who are paid in stock.
A repurchase can increase earnings per share (EPS) and return on equity (ROE) while reducing the price-to-earnings ratio (P/E ratio). Promoters of stock buyback programs cite that these effects can make a stock more attractive for shareholder value.
A stock buyback can be a counterstrategy against a hostile takeover. The fundamentals of a hostile takeover include a tactic of buying enough shares to acquire a controlling stake in another company. Buying back shares is a strategy that aims to reduce the number of available shares while raising the current market price of available shares.
Are There Disadvantages of Share Buybacks?
Money spent to buy back stock is cash flow that cannot be spent on anything else. Buybacks may signal to investors that your company does not have any worthwhile uses for its money. If the stock buyback fails to raise the share price, that money is gone. In a worst-case scenario, stock repurchasing can result in insolvency.
A dramatic upturn or dilution of key metrics such as ROE or EPS can forecast a shift to negative shareholder equity. There is only so much benefit to be derived from repeatedly repurchasing across the long term, mostly because buybacks cost more to the company than simply issuing stock. Artificially inflated ROE reaching certain elevated percentages over time could be taken as a red flag to investors.
New Tax Implications for Stock Buybacks
A non-deductible excise tax of one percent of the fair market value will be imposed on stock buybacks beginning in 2023 due to the Inflation Reduction Act, according to the IRS and Treasury. This may have the effect of discouraging stock buybacks.
There is some controversy around stock buybacks from detractors who claim that investing in share repurchase programs benefits shareholder payouts instead of raising wages or investing in business areas. Shareholders can also benefit from the capital gains income tax rate and deduction of basis when selling stocks back to a company.
Hashaw Elkins is a financial services and tax professional, as well as a project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw holds an MBA in Real Estate and an MSci in Project Management. She is further certified in organizational change management, diversity management, and cross-cultural mediation.