Monday, October 18, 2010

Why Would A Company Buy Back Stock?

Written by Daniel Guttridge

A buyback is when a company buys shares of their own stock on the open market, which reduces the number of shares issued, or the float.

1. SHARE PRICE INCREASE

The laws of supply and demand take effect here. Since the supply of shares is more limited, the price is likely to rise. With the expectations of a price increase, demand usually increases and fuels the price increase.

2. SIGN OF CONFIDENCE

Also, since the company is buying their own shares, it shows that they have confidence in their future. Investors see that the company has confidence and they expect the value of the shares to increase in the long term.

3. AN ALTERNATIVE TO DIVIDENDS

1. Tax issues: Buybacks allow the share owners to pay the taxes on the stock whenever they choose to sell. They only recognize profits when they sell. When you receive a dividend, you have to pay taxes on it by the tax year-end.

2. Dividends are hard for companies to reduce. When a company decreases it's dividend per share, it can be a sign that the company is going through financial trouble. Buybacks can be more opportunistic by having an extended time frame to buy the shares back, which allows the company to choose how much they will buy back at different times.

WARNING

Not every buyback is a good thing, though. Companies sometimes announce buybacks to hide other issues within the company. Some aggressive growth companies will issue large amounts of stock, which will dilute the individual share value. Buybacks can then counter the large issuance of stock and increase the share value.

Generally, a buyback has positive effects on the company's shares, but investors should do strong research (just like with any other investment) before investing in a buyback.

Edited by David Neubert

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