Reviewed by Aug 26, 2020| Updated on
Buyback is also termed as a share purchase. When a firm purchases its own outstanding shares to bring down the number of shares which are available in the open market. Firms buy back shares for several reasons including to raise the value of remaining shares which are available by bringing down the supply or blocking other shareholders from taking over the control.
With a buyback, firms will be permitted to invest in themselves. When the number of outstanding shares in the market is reduced, the proportion of shares that are owned by investors increases. A firm might feel that its shares are being undervalued and perform a buyback with an aim to provide investors with a return.
The share repurchase brings down the number of existing shares which makes each share worth a greater percentage of the corporation. The stock's Earning Per Share (EPS) thus raises while the Price-to-Earnings ratio (P/E) goes down or the stock price elevates. A buyback indicates to investors that the firm has enough cash kept aside for emergencies, and there are fewer chances of economic troubles.
Firms could opt for a buyback even for compensation-related reasons. Often, firms award their management and employees with stock options and stock rewards. To make due to options and rewards, firms buy back shares and give them to management and employees. This helps in avoiding the dilution of the existing shareholders.
Since share buybacks are executed by utilising a company's retained earnings, the net economic impact to investors will be the same as if those preserved earnings were given out as shareholder dividends.
A share buyback could give investors the impression that the corporation doesn't have other profitable chances for growth, which will be an issue for investors who are looking for growth with respect to revenue and profit generation.