When a company purchases its own stock, it’s known as a “buyback.” Companies like to be able to share their wealth with their stockholders, and engaging in a buyback makes this possible.
What exactly is a buyback? Essentially, a buyback occurs when a company purchases its own stock in order to raise the price of that stock for the company’s shareholders. Also known as a “share repurchase,” this occurs when a company buys back its shares from the marketplace.
Because a company can’t act as its own shareholder, repurchased shares are absorbed by the company, and the number of outstanding shares on the market is reduced. It is a classic situation of supply and demand. When a company performs a stock buyback, they are hoping to create demand for their stock by removing some from the market.
For example, if a purse company came onto the market and was successfully selling their bags without competition, there would be no need for them to perform a stock buyback. When a competitor comes into the market however, and sells a similar bag, the company goes in and buys their own bags. What the company is hoping to do here is increase the demand for their bags that are still in the market. When companies go into the market and buy back their own stock, they are hoping that it will do just that.
If a company decides to go down the road of buying their own stocks, there are two options: a tender offer or going straight to the open market. The company can use a tender offer, where it goes out to shareholders and tells them they will buy a certain number of stocks. The tender offer will stipulate both the number of shares the company is looking to repurchase and the price range they are willing to pay.
The other option is that they can use the open market and buy right off the market from brokers or traders, like everyone else. Whichever option the company chooses, it’s going to be expensive process. This is why some people believe that stock buybacks are a bad idea and a waste of the company’s money. In their opinion, companies should be using their excess cash to grow by either buying other companies or to expand into other areas, not just prop up their stock price.