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Stock buyback, also known as "share repurchase", is a company's buying back its shares from the marketplace. The company buy its own shares, making the number of outstanding shares on the market is reduced.
Buyback will have this implication:
• Buyback will make the relative ownership of each investor will increase because there are fewer shares. So if you have Microsoft stock and the company buyback its stock, then your ownership to the company will rise.
• Buyback will change financial ratio. A buyback will increase return on assets (ROA) because cash (asset) is used to buyback stock. Return on equity (ROE) will increase because there is less outstanding equity. Earning Per Share (EPS) will increase because the number of outstanding stock decrease, thus the Price-Earning Ratio (P/E) will decrease. The lower the P/E, the better it is.
Why company buyback their stock?
• The company want to maximize return for shareholders. Remember the increasing ROE and ROA.
• The company thinks that current stock price is too low. Thus, when a company buying its own shares, it says management believes that the market has gone too far in discounting the shares, which means its a positive sign to the investor.
• The company wants to reduce dilution caused by employee stock option plans (ESOP). Giving ESOP means making more available stocks, lowering ROA and ROE. ESOP and buyback have the opposite effect.
• The company thinks that, it’s the best way to use their money at a particular time.
We can’t tell that a buyback is good or bad? But by knowing the company motives behind this buyback, we’ll know whether this is good or not. Beware for company using buybacks just to increasing the financial ratios, without better performance from the company. A poor company may do buyback to give positive signs to investor. Therefore the signs may not show the real outlook of the company.
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