Share Repurchase refers to a company program where the corporation purchases back some of its own shares off of the stock markets or from its own individual investors. There are various reasons why a company would choose to spend its excess profits or cash reserves on such an activity. Generally management believes the price of the stock is unfairly undervalued. This repurchase activity allows them to decrease the total number of shares which are outstanding while making a vote of confidence in the company’s prospects.
The company can go about this in one or more of several ways. They might purchase shares directly from the stock market. They could also provide their existing shareholders with the opportunity of selling their shares back to the firm at a set and agreed upon price.
Companies would be interested in decreasing the quantity of shares which are outstanding on the markets as this directly boosts the earnings per share when they retire the shares which they have repurchased. Shares that they buy back they either cancel out or keep as treasury stock. In either case, they are no longer held by investors or traded publically.
This kind of share repurchase does a number of beneficial things for the financial balance sheets of the firms which engage in them. Since it decreases the aggregate assets of the business in question, this means that the firm’s return on equity, return on assets, and various other measurements of corporate health all improve. The earnings per share (EPS), cash flow, and total revenues also increase faster with fewer outstanding shares. When the business decides to still pay out the identical sum of cash in dividends to its shareholders each year, and the full number of existing shares decreases, then each shareholder will receive a bigger yearly dividend amount.
When the corporation in question increases both its earnings per share and accompanying all around dividends declaration, then reducing the outstanding numbers of shares will boost the dividend growth rate as well. Stock holders are demanding by nature and will expect their company to continue to pay out consistent and growing dividends year in and year out. These share repurchase actions reduce the amount of reserve capital which the business must keep on hand to match the par value of outstanding shares so that they could return a greater amount of capital back to shareholders when they decrease the outstanding amounts of shares.
It is easier to visualize this with a tangible real world example. A company may wish to give out 75 percent of the total earnings to the stake holders and still maintain a consistent dividend payout ratio of 50 percent. The other 25 percent of earnings they could distribute by engaging in a share repurchase program via buying back shares as a complement to the dividend.
Companies buy back their shares because they are convinced that their stock price is significantly undervalued. They believe that this is an efficient means of sinking company money into a vehicle which is also putting the money back into the pockets of shareholders. Each share gains a larger percentage ownership of the company as a result of this endeavor, increasing the value and percentage of each stakeholder’s position in the corporation. Such a share repurchase program will also convince potentially skeptical investors that the business maintains more than sufficient minimum capital reserves for difficult economic cycles and corporate emergencies.
A possible downside to such share repurchase plans lies in the impression that they can convey to analysts and investors alike. It might give out the possibly erroneous idea that the firm has no better prospects in which to sink its excess funds. This could mean that they recognize no good potential opportunities to grow the business. For those investors seeking both revenue and turnover increases, this is the wrong message to send. It is also true that spending the company rainy day fund to buy back shares will prove to be a terrible idea if there is a dramatic downturn in the economy afterwards.