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Saturday, January 12, 2013

Effect of Shares Buyback on Stocks

What is a Share Buyback?

A share buyback is the repurchase of outstanding shares by a company of its own shares in the market. It reduces the total number of shares outstanding and the bought back stocks will be classified as treasury shares.

Buybacks can be carried out in two ways:

1. Shareholders may be presented with a tender offer whereby they have the option to submit (or tender) a portion or all of their shares within a certain time frame and at a premium to the current market price. This premium compensates investors for tendering their shares rather than holding on to them.

2. Companies buy back shares on the open market over an extended period of time.

Reasons for Buyback

A buyback allows companies to invest in themselves. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares a company owns. This effectively boosts its share price, and gives shareholders capital gains.

Below table best illustrates how a share buyback can increase the value of the stock. Assuming that the stock price per share remained at Php5 before and after the buyback, earnings per share will  increase because treasury shares are not entitled to dividend or income allotment.

                       EPS        =        Net Income     /     Total Outstanding Shares

Companies will buy back shares to increase its value and can be a source of capital in the future. They will often reason that their current stock price is undervalued and as such, buying back shares may be beneficial because it can provide additional cash when the treasury shares are disposed at a higher price.


Investors will have to be watchful as companies may opt for buybacks merely to improve its financial ratios or manipulate its stocks price to go up. It is important that the actions of the management are analyzed so as not to deceive the investing public of their true intentions. Finally, as with anything with Mr. Market, there is no certainty that the stock price of a company which entered into a buyback program will be profitable.    

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