Why do companies buy back stock?

The buyout of shares relates to the purchase of shares by the company that issued them. Purchase takes place when the issuing company pays the market value to the shareholders and re-acquires the part of its ownership that was previously divided between public and private investors. Why do companies buy back stock?

Reasons for repurchase

Because companies raise equity through the sale of ordinary and preference shares, it may seem counterintuitive that the company may decide to return this money. However, there are many reasons why a company can buy back its shares, including consolidation of ownership, undervaluation and improvement of key financial ratios.

Shareholders and management may have other reasons to buy back shares:

  • Changing the relative weight of shareholders between those who refuse to sell their shares to the company for reasons of control (ie, to increase their ownership percentage), and those who agree to sell some of their shares, hopefully above their market value. This happened recently with Peugeot.
  • Tax reasons, because it is often less costly for shareholders to acquire cash in the form of share repurchase than in the form of dividends.
  • To send a positive signal, i.e. that the management believes that the company is underestimated. Purchase of shares and their cancellation increases the value of other shares. Given the recent changes in some actions, this can be a very strong incentive.
Why do companies buy back stock?
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  • Debt leverage for related tax breaks. This is not a very convincing motivation, because it overlooks the fact that debt and capital become more risky after buying back shares and are therefore more expensive.
  • Building a reserve of shares, which will later be used to grant share options or as a takeover currency.
  • Smoothing stock price fluctuations for listed companies. But whatever is bought can be resold, and such buyouts, which often take place in small doses, are strictly regulated by market authorities.

How does the company buy its own shares?

How do buy-outs work? There are three main ways a company can buy back:

  • by buying your own shares on the open market
  • issuing a call
  • negotiating a private buyout

The most popular way to buy back shares is to open up the market. In this case, the company simply buys its own shares at the current market price, in the same way as you would do as an individual investor.

On the other hand, when a company presents its shareholders with a call to submit offers, it effectively offers to buy back some or all of its shares directly from them.

The call generally specifies the total number of shares that the company intends to buy back, the price range that it is willing to pay for the share, and the offer expiry date.

The purchase of such shares usually involves paying shareholders a share price that is significantly higher than the current market value.

The last and least common way a company can buy back its own shares is to negotiate their purchase privately and directly from a large individual shareholder.

 

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