Question

• What are stock repurchases?
• Discuss the advantages and disadvantages of a firm’s repurchasing its own shares.

Answer 1

Repurchase of stock means buy back of the shares from the shareholders. Public companies buy back large blocks of their stock when the prices of the shares are low.

Advantages

• Enhanced Share Price : Companies when repurchase shares, experience an increase in market price of the shares.
• Enhanced dividends and E.P.S. : In stock repurchase, the number of shares issued will decrease and thus the D.P.S. (dividend per share) and E.P.S. (Earnings per share) will increase in future.
• Capital structure : A company’s managers use share buyback or as a means of correcting an unbalanced capital structure
• Market Signaling : Repurchase of shares may be interpreted as a sign of management failure.
• Positive psychology : Investors usually perceive it as a positive signal, when there is such an increase in the stock price.

Disadvantages

• Sinking dividends: When the companies spend a lot of money for repurchase of shares and there will be cut in the dividend to the existing shareholders
• The company has to pay too high for the stocks to be repurchased if the shares are not actively traded and when the firm intends to purchase large number of shares
• The company’s stock price may benefit from cash dividends rather than from the repurchase of the shares
• Selling stockholders may not have sufficient information about the implications of repurchase