When should a company buy back stock?



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When should a company buy back stock?

3 Answer(s)


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A company should typically buy back its own stock when it thinks that a stock is being undervalued by the public. Now typically, there could be many reasons for this. There could be a short term challenge with the company's operations that is causing the stock price to ----, because of which the public is scared, and you too fear the price of the company in stock is falling down.

However, if the company's management is confident about the company's future, they should buy back the stock so that in future they will know that the stock price of the company will go up. This will also convey to the stock market a positive sentiment that a company itself believes in its stock price.

Another reason for a company to buy back stock, the second reason, is if there are any macro-economic factors that are beyond the company's control that are affecting the stock, which could lead to the stock price declining.

Such macro-economic factors could be short term or could be medium term, sometimes long term. If it is within a reasonable spun of time, and the company expects these macro-economic factors to pass and the stock market to regain, then the company could also buy back its stock.

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When a company goes public, the ownership is also diluted among many shareholders. For example, if you hold say 4000 shares of Yes Bank in the market and the total number of shares in the market is 1,00,000, then your ownership in the company is 4%. Like you, there may be many such shareholders. And at the end - the owners of Yes Bank are seen to be holding less than 20% of the total shares. A similar thing happened with Flipkart a few days back. Now, there can be a list of reason to buy back the shares:

Shares are undervalued : To elevate the market value of the remaining shares in the market, the company will buy back some of its shares, thereby increasing the faith of the investor, proving that the company is positive about its own shares and has a good revenue growth, to be able to buy back some of its shares. IBM, recently had promised to buy back shares worth $ 15 billion, as this was the only way they felt that the EPS would increase to $20.00

To maintain the optimum ratio: If the Debt - Equity ratio in any company is 2:1 , that means that the company is operating at its optimum best. Some companies buy back shares to get as close to this ratio as possible. Also a few other ratios such as EPS or ROA, ROE, P/E Ratio get a temporary boost. This is done when the company wants to impress some potential investor, or it is also the case if the company is in a position to be merged with another.

To increase the ownership of the original owners : To keep the ownership in the hands of a few people, is the goal of any company. Every shareholder has the right to vote in a public company, to keep this voting power in the hands of a few members of the board, is the best possible scenario.

To prevent hostile takeovers: In the movie, Batman Begins, Bruce Wayne, bought back a large amount of stock of the company Wayne Enterprises, when the company went public. He did it through various other organisations, where his name will not show. This is completely legal,, but it was a hostile take over. he wanted Lucius Fox as the CEO, and he could only do that if he was a majority stock holder. Wayne company floated so many shares in the market, that they did not realize that something like this might happen. To prevent such takeovers, companies might buy back their own shares to protect the interests of it owners.

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