After a company’s stock goes public, it can buy back its own shares. If a company completes a buyback of its shares, it opens up several possibilities for what it can do with the newly acquired securities. Usually companies buy back shares to boost value of its stocks for shareholders, promote tax efficiency and gain back ownership and control.
What is a Stock Buyback?
This article will discuss what a stock buyback is and what happens when a company buys back its shares.
Stock buybacks occur when a company decides to buy shares of its own stock that is listed on the open market.
The company can also purchase shares on the secondary market or from current investors looking to sell their shares.
There are no limits to who can sell their shares when a company announces a buyback. Essentially, the opportunity to sell shares back to the company is open to all shareholders.
When a public company decides to do a stock buyback, it will make an official announcement.
The formal word to look for is “repurchase authorization.”
In the announcement from the board of directors, you will also find details on the amount of money that will be allocated to buying back shares.
Conversely, it might include a specific number or percentage of shares it plans to buy back.
Why Do Companies Buy Back Shares?
There are plenty of reasons why a company would buy back shares. The most popular reason is to increase the value of their shares.
Here are a few of the most impactful benefits of stock buybacks:
Boosting the Value of Shares
One of the main incentives for a company to buy back its own stock is to initiate a rising share price of its stocks.
This works best when there is a high demand for a company’s shares, leading to higher prices. If a company chooses to purchase its own shares, it will further boost the stock price.
After the buyback is complete, the value will be increased for all shareholders.
Promote Tax Efficiency
When it comes to taxes, dividend payments are subject to taxation, while rising share values are not.
In other words, if shareholders choose to sell their stock back to the company, they will be expected to pay taxes on the transaction.
However, if a shareholder decides to hold, they can bask in the benefit of a higher valuation of their shares with no direct taxes.
Enhanced Flexibility
When a company initiates dividends or increases a dividend, it will need to continue making consistent payments over a long period.
This can quickly become a slippery slope because reducing or eliminating the dividend can lead to decreased share values and, in turn, unhappy investors.
That’s why most companies prefer a one-time share buyback as a flexible alternative to dividends.
Key takeaways
Stock buybacks occur when a public company buys back shares of its own stock.
As an investor, you can interpret a stock buyback as a sign of confidence in the company from management.
Stock buybacks can have a plethora of benefits for both the company and its shareholders, including increased valuation, tax efficiency, and enhanced flexibility.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
