Why companies buy back their own shares

Julie Brownlee, Fsp Invest, 16 Oct. 2015

Tags: shares, share buybacks, what are share buybacks, investing in shares, investing,

At first glance it may seem a bit of a strange thing to do, a company buying back its own shares that it sold in the first place.

So what exactly are share buybacks? And why do companies do it?

Let’s take a closer look…

What are share buybacks?

Share buybacks happen when a company buys its own shares back from investors on the stock market. By doing this, it reduces the number of shares in issue.

A company may decide to buy back its own shares to return capital to shareholders. Another more popular way of returning capital to shareholders is to pay dividends.

When a company buys back its own shares, it can increase its earnings per share as there are less shares to apportion earnings to.

But sometimes companies don’t embark on share buybacks with the shareholders’ best interests at heart.

What to watch for with share buybacks

For instance, many CEOs and other key board members may be incentivised with bonuses if they grow earnings per share by a certain amount. If a company buys back its own shares for this reason, this is definitely not in the best interests of shareholders.

Another thing that companies should be wary of is wasting company money to buy back shares or borrowing money to do it.

If a company is buying back shares when the share price is high, this is a waste of shareholders money. And borrowing funds to do it may also not make much sense.

With companies that buy back shares, you want to see them doing it for the right reason at reasonable prices. Otherwise you should question the motivation for the company’s decision.

So there you have it. Why companies buy back their own shares.

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