The ins and outs of share buybacks

Julie Brownlee, Fsp Invest, 18 Aug. 2015

Tags: share buybacks, what are share buybacks, advantages of share buybacks, disadvantages of share buybacks, investing in shares,

When you invest in shares, you hope the share price will rise over time.

As well as seeing a share price rise, it’s always a positive sign when a company returns cash to its shareholders. One of the most common ways of doing this is by paying a dividend.

But there’s another way a company can reward its shareholders. And this is by buying back its own shares.

So what exactly does a share buyback entail? And is it always a good thing for investors?

Read on to find out…

The rationale behind share buybacks

Companies embark on share buybacks so that its earnings (or profits) span across a lower number of shares. By doing this, a company should see its earnings per share (EPS) rise.

By increasing its EPS, the company hopes its share price will rise as a consequence. This means that shareholders see the value of their shares rise and their potential profits increase.

Are share buybacks a good thing for investors?

If a company goes through with a share buyback with the full intention of rewarding its shareholders, then it is a good thing. But this isn’t always the case and it depends how the company goes about the transaction.

In some instances, a company borrows money to buy back its own shares on the open market. This means a company has taken on debt to do it. This isn’t a good thing.

If a company pays too much for its shares in the open market, it’s not a good thing for shareholders either. A company should aim to buy shares when they’re trading for less than they’re worth.

And sometimes a company buys back shares for management gains. For instance, management may have a bonus linked with EPS.

Whilst share buybacks can be good for shareholders, there are times when they are not.

So there you have it. The ins and outs of share buybacks.

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