When a company buys back shares of its own stock from the public in an open market, it is referred to as stock buy back. The reasons for stock buybacks vary but there are three main reasons that make companies decide to buy back shares. A companys decision to buyback shares could be an investment decision, or to effect a change in the companys structure to increase its leverage or could be a payout decision to have an alternative to issuing dividends as well as to save taxes paid on dividends. Undervalued stocks and buybacks are interrelated issues.
Why Companies Buy Back Shares:
When the company feels its shares are undervalued due to the market turbulence of an off and on bear market. It is done to send a message across that the company is confident and is therefore investing in it. Buybacks makes it possible for a company to earn 15% returns during the first three years after a buyback.
The company may decide to invest in itself as it may offer a higher rate of return than other investments.
To protect themselves from hostile takeovers
To change its capital structure, where by it reduces the cost of capital, reduces equity, and adds debts. However, this concept is not as popular as it was once as companies currently seek to lower debt to equity ratio and not increase debts to offset equities.
To share its profits with shareholders, and to distribute excess money. It offers the investors a chance to save taxes as compared to issuing dividends, investors usually pay 20% capital gain taxes for repurchases where as they pay 39% for dividends. This method gives the shareholder the right to receive or decline taxable money. It is a safer alternative to issuing dividends for the company.
To increase a demand for its shares and increase stock prices and to stabilize fluctuating prices
Shareholders Benefits:
Shareholders also benefit from stock buybacks as it results in lesser number of outstanding shares correspondingly increasing earnings per share as well as influence acceleration in the rate of increase. Undervalued stocks and buybacks send a clear message that the company feels its share are not correctly priced, and that it is confident in its growth to demand a better share value. It could be a great pr move for the company if properly executed. It could reflect badly if the firms officers sell their share of the company stock when the company is repurchasing its shares.
If carefully planned and executed, undervalued stocks and buybacks could benefit both the company as well as he shareholders.
There are firms that offer their services as well as products to help run businesses smoothly.
Alexander Gordon is a writer for http://www.smallbusinessconsulting.com - The Small Business Consulting Community. Sign-up for the free success steps newsletter and get our booklet valued at $24.95 for free as a special bonus. The newsletter provides daily strategies on starting and significantly growing a business.
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