Understanding The Pros And Cons Of Share Repurchase Plans

By:    Updated: March 31,2017

A stock buyback program, also called a share repurchase plan, is a company's desire to buy back its own shares from the marketplace in order to own more of its company's stock. Stock buybacks can happen two ways: through a tender offer or through the open market. A tender offer program will spell out exactly how many shares the company will buy back as well as what price the company will pay for those shares. If the company uses the open market, then it does what any investor would do: it buys shares at the price available on the open market. Most companies opt to buy on the open market so they are not locked in to a price that at some point they may not want to pay.

 

To say that a company wants to buy back their stock to increase the value of its shares is accurate, but there often are other motives which companies may never reveal. Buybacks often are depicted as a win-win for companies and investors, but in recent years some question whether companies should spend their money this way. In order to put this in perspective, here are some pros and cons of share repurchase plans.

Pros

  • When a company wants to buy back its stock, it is usually a sign that it thinks the stock is a good buy at the current price. This is seen as good news for investors who own the stock or who want to own it because the company essentially is saying that its stock is undervalued and it is betting on a brighter future.
  • Stock buybacks, especially during recessions or bear markets, include an extra price support that can serve as a safety net for investors in the stock.
  • If all other things stay equal, repurchasing stock means there are fewer shares to buy and that means higher earnings per share number. Some investors specifically look for large reductions in outstanding shares, and if they see that, they will buy that stock.

Cons

  • Companies can use stock buyback programs to cover up for financial problems. When a company buys back their own shares, it can create an artificial lift in their financial ratios, giving market observers belief that things are improving even if they are not.
  • These buyback programs can allow company executives and other insiders to take advantage of stock option programs.
  • The good feelings that often surround buyback programs often cause an artificial, short-term jump in the price of the stock, allowing insiders to sell at this inflated price while individual investors are buying high.
  • If a company uses a lot of cash or borrows a lot of money to buy back shares, it may not have enough money for other things such as investing in its company or buying another company.

Warnings

On the surface, the pros often seem to outweigh the cons when investors look at stock repurchase plans. But here are some things that investors should look out for:

  • If a company spends too much of its cash to repurchase stock, it can hurt the company's liquidity.
  • If a company uses a tender offer to buy back shares and it pays too much, that can hurt a company's value. Overpaying for anything is never a good thing, and if that happens, you don't want to own that company's shares.

Keep these pros and cons in mind if you are considering taking part in a share repurchase program. Doing your homework ahead of time will help you to make the best decision.

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