What Is a Stock Buyback?
When a publicly traded company repurchases outstanding shares of its own stock on the open market (or directly from existing shareholders), this is known as a stock buyback. When a stock buyback occurs, two things happen immediately—the number of shares outstanding decreases, and the proportion of the company each share represents increases.
In other words, after a buyback occurs, existing shareholders (assuming they didn’t sell any of their own shares back to the company) suddenly have an increased stake in the business, both in terms of their percentage ownership and the weight of their voting rights. A stock buyback is often described as a company “investing in itself.”
Why Do Companies Repurchase Shares?
Generally, companies repurchase shares when they have “extra” cash on hand that is not already slated for other investments or operations. This is usually done for two reasons—to increase share value for investors and to reduce share dilution.
To Increase Share Price
Because price is a product of supply and demand, reducing the supply of shares on the market should increase demand, which should, in turn, increase share price, thus delivering additional value to existing shareholders.
Because buybacks are known to increase share price, just the announcement of an upcoming buyback often drives shares up in price as investors scramble to buy in before the buyback.
To Combat Share Dilution
When a company’s employees exercise their stock options, more shares enter the market, causing each existing share to represent a smaller stake in the company. This effect is known as share dilution. Buybacks combat share dilution by removing shares from the market, which results in each remaining share representing a larger stake in the company.
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What Are the Effects of a Stock Buyback?
Stock buybacks have a…
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