A share buyback gives existing shareholders the option to sell their personal stakes back to the company. Such action is taken for a number of reasons, including:
Changing the capital structure
While too much debt is problematic, generally the cost of debt is cheaper than that of equity, and also has the benefit of being tax deductible.
Increasing earnings per share (EPS)
By buying up its own stock and reducing the number of shares on issue, the profit is split between fewer shares, which can boost the share price (at least in the short term).
The move is often interpreted as a signal that management believes that the company’s share price is undervalued.
Reducing takeover risk
As companies accumulate cash, they become attractive takeover targets, because the acquiring company can use the cash held by the target to help offset the cost of the takeover.
While buybacks are typically seen in a positive light, critics question whether it really is the best way for a company to spend its money. This is not only because buybacks can create a degree of a moral hazard for management, whose pay packages are often tied to EPS , but also because every dollar used is money not available to develop new products, acquire a competitor or otherwise invest to grow the business.
For more information about share buybacks, please contact your Elston adviser.