Key metrics like earnings per share (EPS) are calculated by dividing a company’s net profit by the number of shares outstanding. These are not counted as shares outstanding, which has implications for many important measures of a company’s financial fundamentals. It’s important to understand that once a company has bought back its own shares, they are either canceled-thereby permanently reducing the number of shares outstanding-or held by the company as treasury shares. Since stock buybacks remove cash from a company’s balance sheet and potentially reduce the number of shares outstanding, they can have a wide impact on the key metrics investors use to value a public company. How Stock Buybacks Affect a Company’s Value Buybacks are one way to offset this effect. If they issue stock options to retain employees, the options that are exercised over time increase the company’s total number of shares outstanding-and dilute existing shareholders. Growing companies may find themselves in a race to attract talent. Meanwhile, since share buybacks are one-offs, they are much more flexible tools for management. That’s because they risk lower share values and unhappy investors if they reduce or eliminate the dividend going forward. Any company that initiates a new dividend or increases an existing dividend will need to continue making payments over the long term. Any holders who sell their shares back to the company may recognize capital gains taxes, naturally, but shareholders who do not sell reap the reward of a higher share value and no additional taxes. Dividend payments are taxed as income whereas rising share values aren’t taxed at all. After all, why would a company want to buy back stock it anticipated to decline in value? Meanwhile, investors may perceive a buyback as an expression of confidence by the management. The board may feel that the company’s shares are undervalued, making it a good time to buy them. The main goal of any share repurchase program is to deliver a higher share price. While dividend payments are perhaps the most common way to return cash to shareholders, there are advantages to stock buybacks: Increasing the value of its stock and returning cash to holders-in the form of dividends and share buybacks-is how companies maximize value for shareholders. According to this principle, a company should always aim to generate the highest possible returns for its investors. One of corporate America’s highest goals is to maximize shareholder value. When a company buys its own shares, it’s helping to increase the price for its stock by boosting demand, thereby creating value for all shareholders. Here’s how it works: Whenever there’s demand for a company’s shares, the price of the stock rises. In this case, value means a rising share price.

The main reason companies buy back their own stock is to create value for their shareholders. Why Do Companies Buy Back Their Own Stock?

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