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Kenneth Chang

Investment Dictionary


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Stock Buyback

 

stock buyback (share repurchase) is a company’s purchase of its own stock on the market. It is contrary way to pay out capital for shareholders to dividends. Stock buybacks are getting more and more popular because of more friendly capital taxation (depending on the country).

 

Many believe that if company implements stock buyback program, it is a sign that management board sees company’s shares to be undervalued on the exchange. But it is not necessary so. If a company has free cash and doesn’t have valuable opportunities to invest in activity/assets, then it has to choose the best way to pay out the cash for its investors. The most practical ways are dividends and stock buybacks. According to tax system and other circumstances the company may chose one of the way or both of them for capital payments. 

 

During stock buybacks all investors doesn’t get cash directly, but stock buybacks works in several ways:

  • Technical. When company buys its own shares on the stock market it increases a demand for the stock and makes pressure on price increase. Simple economic model of price equilibrium: if the supply stays the same but demand increases, price is also increasing.
  • Fundamental. When company acquires own stock it annuls acquired shares and total outstanding number of shares reduces. When outstanding share number reduces then a part in the company of every shareholder increases. Also earning per share increases, which means lower (more attractive) P/E ratio. Another fundamental analysis ratios and DCF analysis work similarly.
  • Psychological. When company buys its own stock, it looks a good sign. Might be that company’s management sees shares to be undervalued, or some believe that when company will increase the demand for its stocks it will jump even more up (double effect – demand increases more because of believing in its increase).

 

 






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