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Share Buyback: What Does It Mean for Investors? Comments

Kelly Summers   |   April 24, 2008
Share Buyback occurs quite frequently on the stock market (well, at least in good times). The decision to repurchase shares is made by persons who are well-informed about the company�s financial situation. Investors can also use this move to receive short-term profits. And though a share buyback is usually deemed an indicator of a bullish trend, playing upon it might sometimes be dangerous.

The repurchase of shares happens when a company buys its own stock on an open market. It indicates that a company is certain in strength of its financial position. Often a share buyback announcement is followed by an announcement of either split or that its shares are undervalued. It might also happen that a company announces share repurchase right after its stock price fell on bad news or negative analysts� comments. In such a case the company might be only seeking to benefit from the stock�s cheapness. It is also important for investors to know what the number of shares is repurchased. The higher the percentage of repurchased shares to shares outstanding is, the higher chances to profit are.

Why is share buyback beneficial to shareholders and investors?

First, if the company�s profit remains on the same level and the number of shares outstanding increases, the EPS (earnings per share) ratio increases.

Second, increased EPS might in turn signal that the company�s shares are undervalued or have a potential to grow. As a result, the demand for such stock increases and the price goes up.

Third, the remaining shares outstanding make up bigger percentage of the float. If the demand increases, and the supply is insufficient, the stock price will go up.

Fourth, if a company buys its shares back, thus it holds excess cash assets. In other words, it has no problems with its cash flow (you can read why cash flow matters here).

Fifth, companies usually use the market�s weakness in order to conduct the share buy-back more aggressively. This indicates the company is certain as to its situation and it deems its stock too cheap. It often happens that the company announces share repurchase after its stock declined in order to benefit from this. Such actions support the stock price and eventually secure safe investments in difficult times for long-term investors.

Although the share repurchase is deemed a factor of stock price increase due to the reasons stated above, it doesn�t mean that traders should buy stocks of any company announcing a buyback. The buyback might turn to be just a try to manipulate the stock�s price.

As it has been said, share buyback increases EPS, one of the most important ratios used by analytics to evaluate shares. With a correct timing, the company may drive its EPS higher than analysts� estimations, which were based on larger number of shares outstanding before the repurchase. This is why you should beware of shares buyback announcements made in front of income statements.

It is important to know what percentage of outstanding stock the company is buying. Unfortunately, buyback announcements usually do not indicate the percentage of stock repurchase. You need to calculate it on your own in order to understand whether this announcement is worth your attention.

Share buyback announcement and real buyback of stocks are two different things. Many of the repurchases announced were not completed. An announcement might drive the stock price up, but usually for a short term. Consider this fact and you won�t be disappointed if a company doesn�t finish the procedure.

Beware if a company announces buyback when its stock price hits its highs. With a buyback, a company might be trying to influence its lower than expected EPS estimations. One of the ways to determine whether this is true is to compare the P/E ratio of the company with P/E ratios of other companies in the same industry. If the ratio looks way too high, it wouldn�t make sense for a company to buyback its shares at premium, unless this offers significant gains.
After a buyback announcement, stocks usually go up not as significantly as after a split announcement; however it can be played upon as well. Day traders gain the most from such transactions. Buying shares right after a buyback announcement is similar to buying after insiders� purchase. Follow the stock price movements, and when you think the price reached its high, sell the stocks and realize your profits.
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