Why Do Company Buy Back Shares? Reasons to Repurchase Stock

Question: I am a student, currently studying Engineering. Recently I am working on a project on US Financial Market. After lot of study and research on US financial market i found that during the time of recession many US companies in the past one year have started buy back of shares. Thus i have found that companies listed in the Standard & Poor’s 500 index have bought back $400 billion of their own stock. I want to know why these companies adopted this strategy and how is this helping them in making profits out of it. Please help me out in understanding my query.

American companies are now spending more of their profits in buying back their own shares. It is  very statement  made by that “According to reports, in the last 12 months, companies listed in the Standard & Poor’s 500 index have bought back $400 billion of their own stock”. Analysts expect this trend to continue and believe it to be good for the economy. This is because buybacks keep the markets upbeat as it returns cash to investors who elect to sell in a tax-efficient way.

There are two primary reasons for which this trend is likely to continue. Firstly, with interest rates still low the buyback theme would help companies hold investor attention on company shares. Secondly the impending corporate tax reform that may lead to inflow of overseas cash may boost the buyback theory.

The biggest impact of buybacks is that it creates a demand for stocks which at most of the times strips new issuance of equity. Having realized this most companies are trying to create scarcity through buybacks and sell capacity to mop up more revenues from the market. Companies that have aggressively followed buybacks have returned 14.2% annually.

But is buyback a foolish way to use cash which could better be used for future growth. Not many agree on this as they say that buybacks help to keep company stocks afloat at times when there is a less inflow of cash in the market due to policy deficiency or lack of mergers or acquisition. But buybacks are only a short term arrangement and is no substitute for investment in future growths. It is acceptable as long as the markets don’t get fresh impetus from some farsighted policy decisions.

Hope this answers your question and if you have any more question please feel free to ask us any time. 

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