Often when you read the paper or are on Yahoo Finance, there’s always a company announcing a “buyback” leading to happy investors. What exactly is a buyback?
A buyback is essentially the company buying back shares and “retiring” them which decreases the amount of shares available on the markets.
There are generally 2 purposes of this:
1) To distribute earnings among less shares which in turn increases the value of each share
2) Remove shares from the market that can be bought by someone/something seeking leverage in the company (something management hates)
3) Companies also may initiate a buyback to offset the effect of paying employees in stocks and options.
This doesn’t apply very much to college students but is definitely something you should know if you plan on investing long term.
The major banks have been trying to buyback shares forever since the financial crisis but the government has forced them to hold off until recently. The reason for this is that the government didn’t believe banks were holding enough cash to start spending it on buybacks.
For example, this past spring Citigroup (C) was finally cleared by the Federal Reserve to initiate a stock buyback after passing a “stress test” which simulates a recession and checks if a bank can sustain itself without collapsing.
In addition, companies like to buyback their stock when the price is below the book value essentially giving themselves a bargain. Companies can retire the stocks at a lower price and issue them once the stock price goes back up.
Share buybacks also tend to be one of the demands of our divas when they buy a stake in a company. Carl Icahn has been trying to push Apple (APPL) to buyback their shares for months now and we will see whether Apple bends.