A share repurchase is a transaction where a company buys back its own shares from the marketplace. Companies often undertake share repurchases when management believes the shares are undervalued. This action can occur either through direct market purchases or by offering shareholders the opportunity to sell their shares back to the company at a set price.
Key Takeaways
- Share repurchase is a strategic decision by a company to buy back its shares from the market.
- Companies use share repurchases to potentially boost stock value and improve financial statements.
- Firms typically repurchase shares when they have surplus cash and the stock market is performing well.
- However, there is a potential risk of a decrease in stock price post-repurchase.
- Notably, Apple has been one of the largest repurchasers of its stock.
How Share Repurchases Work
Companies decide to repurchase shares from the open market or directly from investors. This action is also known as a share buyback and is usually done to increase equity value, enhance the company’s financial position, or achieve consolidation.
A share repurchase reduces the number of outstanding shares, which in turn increases the earnings per share (EPS). A higher EPS elevates the market value of the remaining shares. After repurchase, these shares are either canceled or held as treasury shares, meaning they are no longer publicly held or outstanding.
When a share repurchase occurs, it impacts a company’s financial statements in several ways. For instance, repurchasing shares reduces the company’s available cash, which is reflected on the balance sheet. Additionally, it decreases shareholders’ equity by the same amount on the liabilities side of the balance sheet. Information on a company’s share repurchase activities is typically found in quarterly earnings reports.
Reasons for Share Repurchases
Share repurchases reduce the total assets of the business, thereby enhancing return on assets (ROA) and return on equity (ROE) metrics when compared to not performing buybacks. By reducing the number of shares, a company’s EPS can grow more rapidly as revenue and cash flow increase.
A consistent dividend strategy combined with share repurchases can reward shareholders effectively. For instance, if a company aims to return 75% of its earnings to shareholders and keeps its dividend payout ratio at 50%, the remaining 25% can be delivered through share repurchases, balancing capital return strategies.
New regulations, such as the Inflation Reduction Act of 2022, include provisions like a 1% excise tax on share buybacks exceeding $1 million to prevent stock prices from being boosted artificially to benefit corporate executives.
Advantages and Disadvantages of Share Repurchases
Advantages
- Undervalued Shares: Indicates that the corporation believes its shares are undervalued.
- Increased Share Value: Reduces the number of existing shares, potentially increasing the value of remaining shares.
- Enhanced EPS: A higher EPS can make the stock more attractive to investors.
Disadvantages
- Poor Timing: Often carried out when there’s plenty of cash, which might not be the best time economically.
- Potential Price Drop: The stock price might drop after repurchase, raising concerns about the company’s health.
- Growth Concerns: Investors may think the company lacks growth prospects if it opts for buybacks over expansion opportunities.
- Economic Risk: Carrying out share repurchases can be risky during economic downturns.
Pros
- Indicates undervaluation of shares by the company.
- Reduces the number of shares, potentially increasing their value.
- Makes stock more attractive due to higher EPS.
Cons
- Could be poorly timed.
- May lead to a drop in stock price, signifying potential company issues.
- Market might assume a lack of growth opportunities.
- Risky during economic downturns.
Real-World Example of a Share Repurchase
Apple (NASDAQ: AAPL) is a prime example of significant share repurchases, spending more than $467 billion since 2012. In the 2021 fiscal year alone, Apple spent $85.5 billion on stock buybacks, in addition to $14.5 billion on dividends.
Taxes and Share Buybacks
The Inflation Reduction Act of 2022 imposed a 1% excise tax on share repurchases exceeding $1 million by U.S. corporations traded on established exchanges, effective from December 31, 2022.
Frequently Asked Questions
Which US Corporation had the Largest Buyback of 2022? Apple (AAPL) with $21.7 billion in stock buybacks in Q2 2022.
Do I Have to Sell my Shares During a Buyback? No, participation in a share buyback is voluntary.
The Bottom Line
Corporations often repurchase their shares for various strategic reasons. While this article highlights the advantages and disadvantages, the debate over whether buybacks are the best use of excess capital continues. As with many practices, share repurchases come with their own set of pros and cons.
Related Terms: transaction, undervalued, earnings per share, equity value, treasury shares.
References
- CNBC. “Apple’s Rise to $3 Trillion Market Cap Shows the Value of Its Massive Share Buybacks”.
- Congressional Research Service. “Tax Provisions in the Inflation Reduction Act of 2022 (H.R. 5376)”, Page 3.
