A share buyback occurs when a company repurchases some of its own stock either through purchasing shares on the open market or by buying shares directly from shareholders through a tender offer at a premium to current market price.
Share buybacks (or simply "buybacks") are typically considered a positive development by investors. A buyback can indicate that the company believes itself to be undervalued. However, if the company happens to be incorrect about its own prospects, then the company has actually done a disservice to its investors.
The share buyback may increase the share price of a company by reducing the supply of shares available for purchase. The investor can benefit from this in two ways: (1) The stock price of said company may go up; (2) The investor's percentage share of the company's earnings is now perceived to be greater by other investors using common investor metrics such as P/E ratios.
Some investors prefer buybacks to dividends, as the shareholder does not have topay a dividend tax. Proponents of share buybacks contend that they represent a more efficient means of returning earnings to shareholders than dividends.
A company may also buy its shares back to help fend off hostile takeover bids. By reducing the number of shares available and driving up the share price, the company using a buyback strategy makes it more difficult for an investor to gain a controlling stake in the company.
Do note, however, that when a company announces a buyback, that does not automatically mean that the company will actually spend all that money. The actual purchasing is at the discretion of management.
The reverse situation of the share buyback is called dilution.
Related Fool Articles
- Will Stock Buybacks Make You Rich?
- Buybacks Can Predict Profits
- The Skinny on Share Buybacks
- Share Buybacks Aren't All Equal
Recent Mentions on Fool.com
- International Fears and More Speculation Drag Dow Lower
- How Dividends Change the Game for Cisco Shareholders
- How to Buy Stock Without Losing Your Shirt
- Merck Stock Is a Good Investment (According to Merck)
- NetApp Initiates Dividend, Increases Stock Buyback, Cuts Jobs
- How Ben Bernanke Ruined the Dow's Good Day