This financial trick can be glad tidings for stockholder or a façade to hide pitiful financial ratios .
In this topic I take an opportunity to define stock buyback (that is also called repurchase). So let’s define it and also examine its functioning:
Sometime company wants to buy, that , exceptional stock of its own company stock , which are not in its control and are in the possession of the public. The company does this usually by two ways:
• Company sends offer to the existing shareholders for buying back some number of shares .This offer is tendered at a price that are already fixed . Usually this buying price is above the current market rate. A time frame is given to stockholders.
• The other way, a company adopts to buy the stock is, buy from the open market .When the market is depressed and share price is low , the company uses this method and buys a certain amount of shares.
Above mentioned two methods are the main methods of buying back shares , but question is here why does a company buybacks its own shares ?
Why Company Buybacks Its Own Stock
On account of various reasons a company buys back its stock from the general public. Some time for the favor of shareholder and sometime these reasons are for less humane purposes.
A few of good and bad reasons are being mentioned below for buying back stock.
• If a company has had a large amount of cash and decide how to further invest it , there can be one option that company distribute a portion of cash to its shareholders.
The company could do this by giving dividends or by buying outstanding shares.Incase a company decides to buy up , shareholders will get benefit both ways if they sell or not the shares. The reduction of outstanding shares will not affect them.
• If low financial ratios are observed in the stock of a company, so, buying back act can give a temporary boost to some ratios.
Key ratios as, earnings per share ‘EPS’, price earnings ratio ‘PE’ seem better because make their base on the shares number . Earnings don’t change even number of shares are getting reduced.
• When a company wants to cover its large employee’ stock option programs, it also buys back stock.
The effect of such programs was out of control in the late 1990s, it was tech boom time, due to this effect stock and stockholder equity got reduced. When a company buys back shares, this act reduces dilution, and in the result shareholders stock value gets increased.
• Sometime companies buy back stocks as protection against hostile takeovers from any other companies. By accumulating outstanding shares from the open market, it makes more complex for a buyer to take control of it .
Stock buybacks may be greatly beneficial for stockholders because it is the best utilization of cash and price is also right. However, be cautious of the financial hand that wants to cover up fragile ratios as well as badly managed plans for employee stock option.