Stock Buyback

Nick Name
A Stock Buyback occurs when a company buys back its own stock on the open market. By doing so, a company can reduce the number of shares outstanding and increase its earnings per share

  • Can be a good strategy when management thinks that its stock is undervalued
  • Considered to be a short-term strategy¬†
    • Can boost earnings in the short term, but doesn't help the company grow total revenue or profits
    • Compared to investing the cash in longer-term projects, facilities, etc.
  • Buybacks are like stock splits: What they giveth in share reduction, they taketh back in shrunken balance sheets

Stock Buyback Conflicts of Interest

  • Many management teams are compensated with stock options
  • Management is thus incentivized to increase the stock price - so their options are worth more
  • Mangement may use buybacks as a way to financially engineer a higher share price (even if the company is not better off)
    • Buying Back shares can increase EPS and Sock Price
    • However, buying back shares may not be the best use of cash or help a company earn more
    • This can be harmful long-term if management buys back shares at elevated levels
    • Alternatives could be dividends or reinvesting in the business

2010s Buyback Popularity

  • In the wake of quantitiate easing and low interest rates, stock buybacks because very popular
  • Many companies issued low-rate debt to buy back shares and boost stock prices
  • Concern:¬† If rates rise, it will be expensive for companies to pay back or refinance these debts!