Question

1. Who would benefit from a stock buyback?

2. What drives companies to repurchase their stock?

3. Does share repurchase seem like an artificial way to raise EPS? If the company has the money to repurchase shares, why can't it find investment opportunities that will increase stock price?

4. In general, what are advantages and disadvantages of share repurchase?

Answer 1

1.A buy back refers to the repurchase of the shares of the firm by the firm itself.A firm resorts to repurchase of its shares when it feels like it's share prices are undervalued.The firm's share prices might have declined a lot and the repurchase maybe the firm of firm trying to correct this.In the event of a buy back both the investors of the firm and the management of the firm will benefit from it.This is because the investors of a firm, invest with the ultimate goal of increasing their wealth the share price appreciation which the repurchase will result in would help achieve that.The management on the other hand is able to increase the stock price and also indicate that the firm is in a good financial position.

2.The management of the firm will be encouraged to buyback it's share when it feels that the shares have been discounted a lot by the market or is undervalued.The repurchase of the shares by the management will result in an increase in stock price and will also indicate that the firm is in a good financial position.Another reason is if the remuneration of the management is tied up to the share price,then the management would be encouraged to repurchase shares so as to artificially inflate the share price .

3.Companies that decide to repurchase their shares are giving an indication to the market that the firm believes that it's shares are undervalued, and the firm is making an attempt to correct this.Another reason maybe to benefit from the remuneration schemes for management that are tied with the firm's earnings.The management might resort to this although this will project a false image pertaining to the company's financial state and growth prospects to the investing public.Another reason might resort to repurchase with the funds it has rather than invest in something else is to reduce the dilution(fall in ownership %)

4.Advantages :The stock buybacks are taxed at a rate that is lower than the rate that dividends are subject to.A buyback will help a company improve some key ratio namely the ROE(Return on Equity) and the ROA (Return on Assets) .It will also help improve the EPS of the firm.Another advantage is that the firm can use it to indicate the cash rich position of the firm to potential investors, and thereby indicate the firm has sufficient liquidity.Another advantage is that it can be used as a defense mechanism against hostile takeover.Disadvantages:In some instances the firm might have to pay a high price to buyback shares. The buyback of shares might be the management trying to project a false image of growth so that they can benefit from better remuneration that has been tied up with earnings.It also implies that the firm does not have other attractive investment options available.