Question

What is a share repurchase and is it better than paying dividends? Compare, contrast and explain your results.

Answer 1

Share repurchase or buyback of shares means where the company buys back its own shares from the existing shareholders. The company buys shares directly from the market or offers its shareholders the option of tendering their shares directly to the company at a fixed place. A share buyback reduces the number of outstanding shares, which increases both the demand for the shares and the price.

In some cases buyback is beneficial. A share repurchase shows that the company believes its shares are undervalued and is an efficient method of putting money back in shareholders' pockets. The share repurchase reduces the no. of existing shares, making each worth a greater percentage of the company. The stock's EPS increases while the PE ratio decreases or the stock price increases. A share repurchase demonstrates to investors that the business has sufficient cash set aside for emergencies and a low probability of economic troubles.

Drawbacks of buyback:

A buybacks, if ill-timed, can prove to be a bad decision. A company will buyback its shares when it has plenty of cash or during a company reconstruction process. The stock prices of a company is likely to be high at such times, and the price might drop after buyback. A drop in the stock price can imply that the company is not so healthy after all.

A share repurchase can give investors the impression that the company does not have other profitable opportunities for growth, which is an issue for growth investors looking for revenue and profit increases. A company is not obligated to repurchase shares due to changes in market place or economy. Repurchasing shares puts a business in a precarious situation if the economy takes a downturn or the company faces financial obligations that it cannot meet.