stock-buy-back

How Does A Stock Buy Back Work?

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.

Connected Business Concepts

Double-Entry

double-entry-accounting
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.

Balance Sheet

balance-sheet
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).

Income Statement

income-statement
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Cash Flow Statement

cash-flow-statement
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.

Capital Structure

capital-structure
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).

Capital Expenditure

capital-expenditure
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.

Financial Statements

financial-statements
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.

Read next:

How To Read A Balance Sheet Like An Expert

Other business resources:

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