What is a share buyback?
When there is talk of share buybacks on the stock exchanges, few investors know what it is really about. As the name suggests, the definition of share buybacks is simple: shares that have already been issued are simply bought back by the issuer (the share issuer). This is often a complex stock exchange strategy that companies pursue for various reasons. A share buyback can send certain signals to the public and trigger positive effects on the stock market.
The condition for such a process is that a corporation is approved by the general assembly to do so and has a correspondingly high liquidity ratio. The share buyback is then carried out either with the help of equity, or a stock corporation takes out a loan to buy back its own shares, which can result in the so-called leverage effect. The use of outside capital increases the return on equity.
How does a share buyback work?
The protocol for a share buyback scheme must be accepted by the general meeting as a resolution in order to be able to carry out a proposed share buyback. There it is also specified which share of the share capital the company may buy. The resolution of the general meeting is valid for up to 5 years and enables companies to complete the buyback program within this specified time. There is a simple reason for the restrictions: In the past, financially troubled companies in particular used the option of buybacks to give certain shareholders priority over the threat of bankruptcy.
As a rule, shares are bought back on the stock exchange. Companies can also submit a buyback offer to their shareholders. This normally arises when there are too few trading opportunities or it is required to prevent the market impact on the stock exchange. Usually, shareholders are paid not only the market value, but also a premium.
4 Reasons Why Companies Buy Back Shares
There are many reasons that lead public companies to buy back their own shares. They enable financial and structural measures.
Price increase: A share buyback is usually aimed at increasing the price of the share. The share buyback leads to a reduction in the number of freely available shares, which increases demand and ultimately increases the share price. In some cases, companies simply liquidate the shares they have bought, which leads to an immediate increase in the value and price of the remaining shares.
Protection: As a result of a share buyback, not only are the available shares on the open market reduced, the existing ones also automatically increase in value. So other companies have a harder time buying into the group. Ultimately, share buybacks protect against an impending takeover.
Means of payment: The repurchased shares can also serve as means of payment or as a so-called exchange or transaction currency in order to take over another group. In such cases, payment is made with the company’s own shares.
Bundling: In the course of a share buyback, the number of shareholders is often reduced. In this way, the corporate structure of the company sometimes changes. For example, the decline in the number of shareholders also reduces the number of those who can have a say at the general meeting. At the same time, the amount of the dividend for the remaining shareholders can increase. Because the profits that are distributed to the shareholders are distributed over fewer shares than before and the so-called price-earnings ratio changes in favor of the shareholders.
What does a share buyback mean for shareholders and investors?
GOOD TO KNOW: Some investors pursue special strategies that aim to include public companies in their portfolio that regularly purchase their own securities. In addition, there are also funds that bundle shares in companies that may or may not be bought back.
A share buyback has several effects that can affect both shareholders and potential investors. Shareholders who remain in possession of their shares can partly hope for a price increase. Because the reduction in the number of shares available often increases the stake in the company that remains. And because there are fewer shares in circulation, the dividend usually increases too.
With the announcement of a share buyback, a company also signals in advance that its own shares can be a sensible investment. Because a share buyback means that the company would like to initiate measures that improve its perspective in the long term. Interested investors can share this optimism by also buying stocks . As a result, the share price ultimately rises, ideally over a longer period of time.
POSSIBLE PROBLEMS OF A SHARE BUYBACK
Share buybacks can offer shareholders and investors quite positive prospects – but they are not entirely undisputed. In particular, if share buybacks are carried out without a corporate concern, this can lead to prices falling again quickly after a brief increase. And if a price increase occurs only briefly, the effect that is actually intended with a share buyback not only fizzles out quickly, the shares also lose their attractiveness in the long term. Investors are also wondering whether the company can think of any other ways to use the capital (e.g. by investing more in research and development). The possibility of financing share buybacks with the help of debt capital can also maneuver companies into financial difficulties. Because loan interest can only be serviced as long as the company is generating profits. If this does not happen or if the share price does not develop as hoped, the stock corporation threatens to become overindebted.