Share Buyback: Why Do Different Companies Rebuy Shares?

By Indeed Editorial Team

Published June 1, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

The buying and selling of shares in a company is a critical part of the stock market. A company's share value can help show the financial well-being and value of its business. Learning about how share buybacks can affect the stock market may help you make good investment decisions on behalf of a company. In this article, we explore what a share buyback is, define shares, explain the various reasons a company may buy back shares, determine their disadvantages, learn their advantages, and discuss how companies can increase market share.

What is a share buyback?

When a firm repurchases its own shares from the stock market, you can refer to this as a share buyback. Companies pay for buybacks using extra cash or borrowed money. Typically, a business can repurchase shares when it has surplus money or when the firm is financially sound. A stock buyback either eliminates the stock from the market totally, distributes the purchase price to employees through equities, or retains the stock for future resale.

What are shares?

Shares, or stocks, are fractional ownership units of a business. Shareholders, or stockholders, acquire shares to participate in a business's transactions. This means that they own a portion of the business and can benefit from the earnings. There are two types of shares available:

Equity shares

Equity is the market value of a company's stock and businesses use it to determine the worth of the firm, its inventory, or a single stock. Employers may provide equity remuneration to their employees. This is a type of non-cash remuneration that provides employees with a stake in the organization for which they work.

Equity as pay or equity benefits are gaining popularity and may be a fantastic investment option. Equity shares, or ordinary shares, are a kind of stock that a company may trade in the stock market. While equity shareholders get a vote on business matters, ordinary shareholders receive dividends from a company's net profit.

Read more: How to Become an Equity Trader (With Steps and Salary)

Preference shares

Preference shares are equities that provide owners with extra rewards according to a company's profitability. The company distributes the profits to preferred shareholders before it distributes them to regular shareholders. If the company collapses, preferred shareholders might receive payments before regular shareholders. Three distinct types of preference shares exist:

  • Cumulative preference shares: Cumulative preferential shareholders may get dividends late before the corporation distributes them to common shareholders. For instance, if the organization didn't pay dividends the previous year due to financial difficulties, preferred shareholders may get dividends in addition to the current year.

  • Non-cumulative preference shares: Non-cumulative shareholders can't claim previously missed dividends. They can only claim dividends for years where the company makes a profit.

  • Convertible preference shares: Convertible shareholders may convert their preference shares into equity shares. Share conversion requires company approval.

Why do companies buy back shares?

There are many reasons a company may buy back its own shares, including:

Increase the value of shares

If a company believes its own shares don't have the correct value, it may repurchase them. The company increases its profits per share, or earnings per share (EPS), by repurchasing shares. Consider Sam's Seafood Company, which has a market capitalization of $100 per share. This corresponds to a $2 profit per share. Sam's Seafood Company's EPS increases by 25% if it repurchases 25 of those shares. The EPS per share is $4 when the 25 available shares have a value of $100.

Increase profit from attractive shares

Because repurchasing shares may increase a company's financial performance, a business might repurchase its own stock to help boost profits during moments of heavy buying. For instance, if Sam's Seafood Company feels its stock is attractive and has the potential to generate profit, it may repurchase numerous shares to increase the expected profit. Repurchases may enhance an investor's perception of the stock's value, which can make already attractive shares even more so.

Read more: What Is Equity in a Company? (With Definition and Types)

Increase equity for employees

When a business repurchases its own stock, it may distribute the value of the stock, or equity, to its employees. A business may give equity to employees as a kind of non-cash remuneration. Equity provides employees with additional ownership in a business, providing for future investment options. Additionally, businesses may give stock to help enhance benefits to attract new personnel or retain existing ones.

Increase invested capital

An organization may grow by offering equity to shareholders. To retain shareholders, businesses compensate stakeholders for the cost of equity. If a corporation has little expansion potential, maintaining numerous shares and stockholders may not be financially prudent. Companies may choose to acquire their own shares to reinvest resources elsewhere rather than continue to pay for unnecessary shareholders.

Disadvantages of share repurchase

The two major downsides of buying back shares can include:

Timing challenges

Because organizations may buy back shares to benefit from future stock market fluctuations, repurchase attempts may experience timing difficulties. For instance, a corporation may repurchase stock to increase profits when its shares are trading at a premium. If stock prices fall after a repurchase, the company's earnings may not gain profits as it expects.

Investor effects

A drop in stock price after a buyback may show stock investors that the company is financially unhealthy. Potential investors may believe a company has no other profitable growth opportunities if the business continuously repurchases its own shares. Also, if the stock prices drop after a buyback, a company may not have excess finances to meet financial needs.

Advantages of share repurchase

Here are two major benefits of buying back shares:

Increases shareholder's stock value

When a company buys the stock back, current shareholders gain more valuable shares. Stock repurchases reduce the number of shares, which can increase the value of each stock. Allowing stockholders to have increasingly valuable stocks can help keep shareholders satisfied and may generate more demand for a company's stocks.

Shows a business's financial health

As businesses repurchase shares using excess funds or with money from loans, buybacks can help show investors that a company is financially healthy. Also, because buybacks often increase the value of a business's stocks, higher stock value may help further show that a company is financially healthy. Companies usually buy back stocks when the market undervalues their shares, so investors may see buybacks as opportunities to purchase valuable shares.

How companies can increase market share

The following are several ways companies can increase their overall market share:

Remain relevant

It's vital for companies to remain relevant within their sector. One approach to do this is by ongoing innovation and development of new goods and services targeted towards the business's ideal audience. Other techniques for staying relevant include polling customers periodically to ascertain their preferences for the company's goods or services, emphasizing the consumer experience, and engaging its customers via marketing efforts.

Read more: A Guide to Risk Management Process (With Practical Examples)

Increase employee satisfaction

It's essential for employee motivation to provide high-quality goods and services. Motivated individuals can show their commitment by contributing to the creation and implementation of a new product or service. Companies can increase employee motivation by providing a more flexible work environment, improving employee engagement, and allowing employees to focus on initiatives they like.

Read more: What Is Pay Inequity? (With Employment Laws and FAQs)

Market to a more specific demographic

When businesses promote to a mass market, they often do it via general population marketing. This implies that although their marketing may attract some customers to their goods or service, the majority may not respond to them due to their generic appearance. Concentrating on a niche market enables an organization to tailor its marketing efforts to the unique requirements and concerns of a population, increasing the probability that the demographic might gravitate toward the business.

Read more: What Is a Market Segment? Definition, Benefits, and Steps

Establish a distinctive brand position

Distinguishing the company from its competitors is critical for increasing market share. When the company differentiates itself from other businesses in its field, clients tend to purchase more from the firm than from its competitors. One strategy for developing a distinctive brand position is to identify what the company's competitor lacks and incorporate it into the organization's plan.

Prioritize new and current clients

Keeping existing customers engaged and happy is critical for customer retention and referrals. Prioritizing new clients is critical as it enables a company to grow its customer base. The organization can use customized communication tactics, such as marketing emails, and ensure that it answers clients promptly.

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