What is a buyback and why do companies do it?

Buyback is a process widely used by listed companies today. It’s also called share repurchase, as it consists of a company buying back its own shares to reduce the number of shares available on the market. Let's take a look at what this means and why companies resort to share buyback.

Share buyback is an increasingly common transaction on the financial markets. It’s when companies buy back their own shares from investors., They can then decide to redistribute them in the future, retain them, use them to pay bonuses to managers and employees, or cancel them.

For a company the process of buying back their own shares can take place by either buying the shares directly on the market, or through a public offer. Clearly, the company must have enough liquidity available for the share buyback, as it requires significant capital.

There are several reasons companies may buy back their own shares. The most common one is to increase the value of shares, as buying back some of the stock reduces the number of shares available to investors. In fact, a decrease in supply drives up the share price if demand remains stable or increases.

Buyback often happens as a result of companies going through a difficult time.  They can potentially increase their share value and change investor perceptions through a buyback.

Share buybacks may also be used to make acquisitions and pay for them in shares rather than cash. This avoids issuing new shares that may then harm existing shareholders by diluting the value of their holdings.

The buyback process can also be used to remunerate managers and employees with shares instead of cash, or to comply with stock option plans that allow management to buy shares in the company at a predefined price.

In general, share buyback raises the value of earnings per share, so that shareholders who own the company's stock can make more of a profit.

Another reason for buyback can be high liquidity. If a company has a lot of capital at its disposal but doesn’t plan to make acquisitions, investments or business expansions, it may decide to use some of its cash for a buyback to increase the value of its stock. This potentially saves the company money, as high liquidity can be expensive to maintain and there’s also the risk of its value being eroded by inflation.

Nowadays, many listed companies periodically perform buybacks, especially Wall Street companies.

One example is Apple, a company that often resorts to share buybacks depending on its quarterly results, partly due to the enormous liquidity held by the American technology company. Apple's last buyback took place in the second quarter of 2022, when the board of directors authorised a $90 billion buyback, while in 2021 the company spent $88.3 billion on share buybacks.

Alphabet, the holding company that runs Google, also decided on a $70 billion buyback following its below-expected quarterly results for the January-March 2022 period, after spending $52 billion in 2021 to buy back its own shares.

More recently Tesla CEO, Elon Musk, signalled the possibility of the American electric car company doing a buyback in the future, depending on its cash flow. This would be to stem the negative effects that may come with the spectre of economic recession.

Buyback has pros and cons for companies and investors and these need to be carefully evaluated to fully understand this type of transaction.

The potential advantages of stock buybacks include:

• short-term value creation
• increase in profit
• increase in the market price of shares
• shareholder benefits
• possible financial cost savings

Potential negative aspects of share buybacks include:

• below-expected returns
• new debt to finance the buyback
• greater financial fragility for the company

lower resilience to economic crises

A listed company’s buyback announcement has a certain impact on the markets, influencing the company's share price. With online trading you can potentially take advantage of this information to speculate on the price movements of stocks on the stock exchange, using CFDs to open short and very short-term uptrend or downtrend positions.

Before investing, however, you should take the time to understand the reasons for the buyback to consider whether to view it positively or negatively. A case-by-case assessment is crucial  to determine the exact reasons for the share buyback and the possible impact on the company's accounts. You should also – as always - pay close attention to risk management, for example by setting automatic stop loss orders.

With Fineco’s trading solutions you can invest in shares or other assets simply and intuitively and take advantage of news about corporate events, such as buybacks, to open positions on any price direction.

If you are happy to take the risks associated with leveraged trading, CFDs trading with FinecoBank allows you to invest in your favourite assets, create customised strategies and take advantage of professional analysis tools. What’s more, you don’t have to pay fixed fees or a a minimum deposit.