Question

What are the advantages and disadvantages of stock repurchasing ?

Answer 1

Every Organization produce cash in its own way, but a successful organization handles cash in a correct way and this can be done in different ways and one of the way is "Stock Repurchasing". The term "Stock Repurchasing" would be defined as a transaction where company buy back its own shares from the market. Basically, the company would be considered as public-traded company as they use its own cash to buy them. These are the "Issued Shares" of the company hold by the shareholders and investors. The buy back of shares takes place when the company believes that they have become undervalued and they purchase directly from the market or they provide an offer to the shareholders to give an option of tendering the shares to the company at a fixed rate so that they can buy directly from them. The Company tend to use this practice when they have cash on hand and there is an increase in Stock market.

Advantages of Stock Repurchasing

There are multiple reasons of why company choose for "Stock Repurchasing", few of them are described below :

• Stock are undervalued : It is when the company feels that the stock has become undervalued as per the intrinsic value then they resell the share when the market reaches on the value as per the intrinsic value of management. For example, if a company thinks that the value of the share is $30 and the market value of the share is $20 then they will resell them till its get the value of $30.
• Excessive Cash Reserves: It is when the company has a excessive cash then they may choose to repurchase the share instead of investing in a new factories. As this would increase Issued Shares of a comapny to a new investors or they may pay the employees in terms of stock options given to them.
• Prevention of Takeovers : Management may opt for Buying back of shares as an action of defending them from rival company to take over. If a company has an oustanding stock of shares there is a probability that rival can try and buy those shares so "Stock Repurchasing" helps you to prevent that.
• Improvement in Financial Ratio : Managers engage in Buy back of shares to enhance there financial ratios, specially earning per share or diluted earning per share. If the company repurchase the shares it will increase the earning per share of the remaining shares.
• Preserve the Stock Price : In case of recession or when economy is hitting low company has to cut off dividends to preserve cash. This will lead to sell off in the stock by the shareholders. However, if stocks are repurchased by the company then they can use them for preserving cash and also the price of share would not fluctuate much.
• Change the Capital Structure : The buy back of shares changes the capital structure of a firm, and there is no need of the company to reissue the share which is a mandatory obligation for them as they can use it for there retirement programmes (such as bonds etc), bonuses or any other reissue option.

Disadvantages of Stock Repurchasing

After having several advantages of "Stock Repurchasing" there are also disadvantages for the same which are as follows:

• Inappropriate time : The company will opt for buy back of shares when they have excessive cash or if the financial health of the company is good. In this scenario, the stock price of the company is high but the price might drop after the practice of repurchasing. And the drop in stock price can indicates that the company is not so healthy
• Creates Bad Impression : The practice of "Stock Repurchasing" creates a bad image in front of the investors as the growth investors would feel that the corporation does not have a profitable growth in future and it will not give them increase in revenue and profit.
• Risk factor: "Stock Repurchasing" puts company at risk as they spend too much to buy there own shares. If market overall hits low company can suffer serious losses.
• Cash Block : Other departments like research and development of company might suffer because the cash is blocked and company runs out off money to invest in these departments.
• Unrealistic picture of ratios : It creates an unrealistic pictures of financial ratios as it shows the increase in profitability but actually it is a decrease in outstanding stock of the company.
• Improper valuation : "Stock Repurchasing" leads to improper valuation of company as most of the shares are in possession of the company which creates judgement error.

Conclusion:

"Stock Repurchasing" have always been controversial because it has both advantages and disadvantages for company and shareholder. In depends on the company how much should be buy back and how much should be left in outstanding. Looking at the pros and cons of "Stock Repurchasing" the company has to take a decision which is beneficial for the company as well as for the share holders.