Stock Buyback

What is a Stock Buyback?

A stock buyback is when a company decides to buy back its own shares from the stock market and cancel them. This has the effect of reducing the overall share capital.

The move, which is also known as share repurchase, is part of a broader business strategy that can be carried out for a number of reasons.

Here we examine the benefits of stock buybacks, how a company can launch its own stock repurchase program, and whether such a move is good or bad for investors.

Table of Contents Table of Contents

1. What is a Stock Buyback?
2. Key Takeaways
3. How A Stock Buyback Works
4. Reasons Why Companies Buy Back Their Own Stock
5. How Stock Buybacks Affect a Company's Value
6. An Example of How Buybacks Work
7. Is There An Appetite For Buybacks?
8. Tax Implications of Stock Buybacks
9. Stock Buyback Pros and Cons
10. The Bottom Line
11. FAQs
12. References

Show Full Guide

Table of Contents

1. What is a Stock Buyback?
2. Key Takeaways
3. How A Stock Buyback Works
Show Full Guide
4. Reasons Why Companies Buy Back Their Own Stock
5. How Stock Buybacks Affect a Company's Value
6. An Example of How Buybacks Work
7. Is There An Appetite For Buybacks?
8. Tax Implications of Stock Buybacks
9. Stock Buyback Pros and Cons
10. The Bottom Line
11. FAQs
12. References

How A Stock Buyback Works

Now that we understand the stock buyback definition, we can pose the question: “How does a stock buyback work?”

There are several ways to facilitate a stock buyback and the chosen route depends on factors such as the company’s favored route and the number of shares being repurchased.

Interest rates can also affect the appetite for buybacks. When the cost of borrowing is low, this can incentivize management teams to borrow money to spend on buybacks.

Of course, higher borrowing costs have the opposite effect. For example, reports last year indicated that share buybacks on the US stock market had dropped due to rising interest rates.

Methods of Stock Buybacks

We have answered the question: “What does stock buyback mean?” Now we examine the various methods by which a company can make repurchases.

Reasons Why Companies Buy Back Their Own Stock

To fully understand the stock buyback meaning you need to answer the question: “Why do companies buy back stock?”

According to Ben Lofthouse, head of global equity income at Janus Henderson, it’s all about companies finding a balance between capital expenditure, their financing needs and shareholder returns.

He stated: “Many companies use buybacks as a release valve – a way of returning excess capital to shareholders without setting expectations for dividends that might not be sustainable long term. This is especially appropriate in cyclical industries like oil or banking.

There are many reasons why a company may decide to launch its own share buyback program. Here we highlight three possibilities and how these stock buybacks are explained to investors.

How Stock Buybacks Affect a Company’s Value

So, what do stock buybacks do to the valuation of a company? For investors, is it good or bad news that a management team has gone down this route?

Well, it’s not a straightforward question to answer, as there are variables at play that will dictate whether or not a buyback is positive.

Generally, the hope is that reducing the number of shares in circulation will fire up demand among investors, and, as a result, the stock price.

The earnings per share should also increase because fewer shares are in circulation, according to Santander. “Shareholders will have a greater stake in the company’s profits,” it stated.

However, Adam Fleck, director of research, ratings and ESG for Morningstar Research Services, has questioned whether buybacks boost value for investors.

In a Q&A session, he pointed out that to create long-term value, buybacks have to be done at a price that’s below their intrinsic value, which is known as the fair value estimate.

“Many buybacks are done at the opposite, above fair value, and it ends up actually destroying value for shareholders,” he stated. “So, that’s a really important consideration to make when thinking about the potential success of buybacks.”

An Example of How Buybacks Work

Let’s take a look at a stock buyback example.

In August 2024, Banco Santander announced a share buyback program worth EUR 1.525 billion, which was around 25% of its underlying profit for the first half of the year.

The scheme, which will run until at least January 3, 2025, is part of the first tranche of annual remuneration for the company’s 3.5 million shareholders.

It stated: “The bank’s remuneration policy, in force since our Investor Day, stipulates a payout of around 50% of our underlying profit, split almost evenly between a cash dividend and share buybacks.”

Is There An Appetite For Buybacks?

It’s also worth looking at the international buyback market to see whether there’s been much appetite for repurchasing.

Global share buybacks fell to $1.11 trillion in 2023, representing a fall of $181 billion (14%) on the previous year, according to Janus Henderson Investors.

However, the report noted that the decline came from “a very high base” and still leaves the annual total well above pre-pandemic levels.

It stated: “US companies were the biggest buyers of their own shares, totaling $773 billion in 2023 and accounting for $7 in every $10 globally.”

However, US buybacks fell 17% year-on-year ($159 billion), with  US technology companies cutting back the most. They spent $69 billion less than the previous year.

“Among these, Microsoft and Meta reduced buybacks by almost one-third, and Apple by one-seventh,” it added. “There were also big reductions across much of the US healthcare sector and among financials, though not across the banking sector, where cuts by some banks were more than offset by rises elsewhere.”

Tax Implications of Stock Buybacks

You will need to check the tax implications depending on where you are in the world as tax is a complicated area.

In the US, the Inflation Reduction Act (IRA) became law in August 2022 and that has had an effect on repurchases, according to an analysis by KPMG.

“Among other things, it imposes a 1% excise tax on net share repurchases in a tax year that are made by certain publicly traded corporations,” it stated. “The tax applies to repurchases of common and preferred shares, net of issuances, in a tax year.”

Stock Buyback Pros and Cons

The Bottom Line

The clearest stock buyback definition is that it’s a business strategy that sees a company repurchase some of its shares from the stock market.

There are many reasons why a management team may decide to go down this route. For example, it may have surplus cash on the balance sheet and nothing to spend it on.

However, analysts are divided when it comes to whether a buyback is value-enhancing for a company, so investors need to understand the reasoning behind the move.

FAQs