What is a stock buyback and why do companies do it?

Key takeaways

• A buyback reduces the number of shares outstanding.
• It returns cash to shareholders as an alternative to dividends.
• Fewer shares raise EPS even without profit growth.
• Value depends on the price paid and how the buyback is funded.
• Check whether the share count actually falls.

A stock buyback, or share repurchase, is when a company buys its own shares back from the market. The repurchased shares are usually cancelled or held as treasury shares, so fewer shares remain in circulation.

How buybacks work

The board approves a buyback programme, often stated as a maximum amount of money or number of shares over a period. The company then buys shares, usually gradually on the open market. Other methods include a tender offer to shareholders at a set price or an accelerated repurchase through a bank.

An authorisation is not an obligation. Companies can slow down or stop a buyback.

Why companies buy back shares

• Return cash to shareholders. It is an alternative to dividends. Shareholders who do not sell end up owning a bigger slice of the company.
• Belief the shares are undervalued. Management may see buying its own stock as a good use of cash.
• Offset dilution from employee stock options and share awards.
• Flexibility. Unlike a dividend, a buyback can be adjusted without the same negative market reaction as a dividend cut.
• Tax considerations. In some countries, shareholders are taxed less on buybacks than on dividends, because they only pay tax if they sell.

Effect on EPS

Earnings per share (EPS) = net income ÷ shares outstanding. If profits stay the same and the share count falls, EPS rises. For example (illustrative), profit of 100 million and 100 million shares gives EPS of 1.00. After buying back 5% of shares, EPS becomes about 1.05 with no change in profit.

This is why it is useful to look at net income growth and EPS growth separately.

Big buybacks in practice

Large US companies such as Apple, Alphabet and Meta have run very large buyback programmes. Apple announced a then-record 110 billion dollar authorisation in May 2024. Check each company’s latest filings for current amounts.

Criticisms

• Buying high. Companies sometimes buy most when prices and profits are high and stop in downturns.
• Short-termism. Critics argue cash might be better spent on investment, wages or debt reduction.
• Executive pay. If pay is tied to EPS, buybacks can boost bonuses without real growth.
• Debt-funded buybacks increase leverage and risk.

Buyback taxes and rules

Since 2023, the US has applied a 1% excise tax on the net value of stock repurchased by listed companies. In the EU, buybacks are governed by company law and the Market Abuse Regulation, which includes safe-harbour conditions on volume and price.

How to evaluate a buyback

1. Is the share count actually falling, or just offsetting stock compensation?
2. Is the buyback funded from free cash flow or debt?
3. Is the share price reasonable relative to earnings? See P/E ratio.
4. Is the company still investing enough in its business?

Common mistakes to avoid

• Treating EPS growth from buybacks as business growth.
• Ignoring stock-based compensation that offsets buybacks.
• Overlooking debt-funded repurchases.
• Assuming an announced authorisation will be fully used.

Bottom line

A buyback returns cash to shareholders by shrinking the share count. It can be a good use of excess cash, but it depends on the price paid and how it is funded. Compare it with dividends and look at the net change in shares outstanding.

Frequently asked questions

Are stock buybacks good for shareholders?

They can be when the company has excess cash and buys at reasonable prices. Buybacks funded by debt or done at high prices can destroy value.

Does a buyback raise the stock price?

It increases demand for shares and EPS, but the price still depends on the company’s results and valuation.

Buyback vs dividend: what is the difference?

A dividend pays cash to all shareholders. A buyback pays cash only to those who sell, while remaining shareholders own a bigger share.

Is there a tax on buybacks?

In the US, a 1% excise tax on net repurchases applies since 2023. Shareholder taxation varies by country.

What is a buyback authorisation?

Board approval allowing the company to repurchase shares up to a set amount or number; it is not an obligation.

Do buybacks pay me cash?

Only if you sell shares. If you hold, you own a larger slice of the company instead.

Sources

• SEC Investor.gov: Stock buybacks
• Apple: Q2 FY2024 results and 110 billion dollar buyback
• IRS: Excise tax on repurchase of corporate stock
• Regulation (EU) No 596/2014 (Market Abuse Regulation)

This article is general education, not financial, tax or legal advice. Hodlia.fi does not recommend buying or selling any asset. Check current rules and do your own research before making decisions.