Share buyback, or share repurchase, is when a company buys back its own shares from investors. It can be seen as an alternative, tax-efficient way to return money to shareholders. Once shares are repurchased they are considered cancelled, but they can be kept for redistribution in the future.
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A company might choose to repurchase shares for many different reasons, but the main reason is that its stock is undervalued, and the company wants to increase demand. Share buybacks reduce the number of shares in circulation, which can increase the share value and the earnings per share (EPS).
To calculate earnings per share, the company’s net income is divided by the number of shares in issue. By reducing the number of shares, EPS will naturally go up. For example, if the company’s net income is $1 million and there are 10,000 shares outstanding, the EPS is $100. But if the company buys back a portion of its shares, the EPS will increase.
Share repurchases can create a positive impression with the public, by assuring them that the company has enough cash to repay its investors. However, it could also create a negative outlook, by encouraging the belief that the organisation doesn’t have any growth potential.
Let’s say company ABC has $20 million in cash and 1 million shares in issue, trading at a price of $10 per share. If ABC buys back 150,000 shares, using $1.5 million in cash, it’s left with 850,000 shares in circulation and $18.5 million in cash.
The stock price will likely rise due to the reduced supply and so will the earnings per share.
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