The practice of a firm purchasing its shares from the current holder is known as stock repurchase or stock buyback. Simply put, the corporation buys back the stock from the capital market at the market price. Or they go to the large holders and arrange a set price that is greater than the market. In today’s market, most public businesses employ stock repurchases to restore value to their shareholders.
However, there are several people still not aware of these terms. Mainly those that never perform the activity. This repurchase is something necessary for business owners and investors too. Therefore, to help give some overview about it, the below paragraphs will help to explain more about stock repurchase.
What is a Stock Repurchase?
A stock repurchase occurs when a publicly traded firm uses its capital to purchase shares of its stock from the open market. When a corporation goes public, it issues shares of stock that individuals or institutional investors can buy. Each share of that stock represents one small piece of ownership in that company, and as a partial owner, whoever owns that stock has a claim on a portion of the earnings earned by the company they own a portion of.
This stock repurchase is the procedure by which a firm purchases its shares from the market with cash. These are a type of reinvestment in and of themselves. When shares are repurchased, they are absorbed back into the company, reducing the number of shares available on the market. The gain to shareholders stems from the share decrease, which raises the value of each share owned.
Reasons for Stock Repurchase
There are several reasons why the business owner performs a stock repurchase. It is a common thing in the stock market. Some of the reasons for the activity include the following points.
The stock price is undervalued
When the share is selling at a lower price although the company’s valuation is considerably higher, management may sense an opportunity. They can decide to buy back and hold for a brief period before selling to the market for a profit.
To increase the share price
As previously stated, share buybacks can enhance share price when the number of outstanding shares reduces (supply decreases) and demand remains constant. It will aid in the improvement of the stock price and financial performance. When a corporation purchases its stock, the market perceives it as a favorable indicator for the future. Furthermore, when the number of shares decreases, the EPS will rise. It is one of them.
Get rid of any extra funds
Some large corporations, such as Apple, have enormous surplus cash that remains after reinvestment, therefore another way to use the capital is to purchase back the stock. When the company issues share to raise finance for expansion, they will purchase back the shares to regain ownership.
Altering the capital structure
The company is invested in both debt and stock; the proportion between the two alternatives varies based on the risk, law and regulation, and shareholder purpose. To reduce tax, management may decide to buy back the shares and replace them with debt.
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Stock Repurchase Risks
Even though for some business owners stock repurchase is a good decision to do, there is always risk in any action. Including when a business owner performs this repurchase. Several risks need to be considered as their impact. Some of the common impacts that mostly happen are included in the lists below.
A scarcity of investing opportunities
Investors may conclude that the company has no investment opportunities and elect to repurchase shares rather than use the capital to develop the business. After the buyback term, the share price will fall.
Other financial obligations cannot be met
Using the spare cash to purchase back the share without sufficient planning may result in a shortage of finances to meet other financial obligations, potentially leading to bankruptcy.
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The Mechanism of Stock Repurchase
Commonly, there are two main mechanisms for performing stock repurchase. The two methods are listed in the below points.
Shareholders of a company get a tender offer in which they are asked to surrender, or tender, a portion or all of their shares within a certain time limit. The offer will specify the number of shares that the corporation wants to repurchase as well as the price range for the shares.
Investors who accept the offer will specify the number of shares they wish to present as well as the price they are willing to accept. Once the corporation has received all of the proposals, it will determine the best mix to purchase the shares at the lowest possible cost.
A firm may also purchase its shares on the open market at market value. However, the announcement of a buyback frequently leads the share price to rise since the market interprets it as a positive signal.
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Stock repurchases have undoubtedly been the primary driver of shareholder value over the last bull market. It will continue to be so in the future. According to the Wall Street Journal, overall activities related to this spending up to $940 million in 2019. Although it has been popular among public firms for capital allocation, there has been considerable criticism of this practice.