Share buyback

Definition: A formal decision and announcement made by a company to commit a certain amount of its cash to repurchasing its shares on the open market in the months and years ahead.

Example: On October 24, 2014 prescription drug maker Pfizer announced that its Board of Directors had authorized the use of up to $11 billion of the company’s cash to repurchase its shares.

Investeach explains: Share repurchase programs are generally a signal to investors that a company believes its shares are undervalued and that it intends to support the price of its stock by purchasing shares on the open market and accumulating them in its Treasury. This takes shares out of circulation, thus reducing the number of shares outstanding. This boosts the ownership of remaining shareholders who will own a greater percentage of the company than before. We could say that their ownership is *concentrated*, the opposite of diluted.

Companies that announce these programs have decided that repurchasing their shares is the best use of the company’s cash. Critics believe this is an admission by the company that it is approaching a dead-end and is out of ideas for growing its business. BusinessWeek magazine has done a series of articles on ExxonMobil showing how over the last eight years, the company has not been able to increase the amount of oil it is pumping out of ground despite spending about double what it did eight years prior. What has caused its total revenues and earnings to increase is the rising price of a barrel of oil. What has caused its earnings *per share* to increase even more dramatically are share repurchases each year that are so enormous that they cost several times more than the company spends exploring for oil! This method of growing a company’s earnings per share, and the subsequent increase in the price of the company’s stock, is not sustainable over the long term. Continuous share buybacks causes the company to shrink as it essentially eats itself.

Despite the press coverage that accompanies share repurchase announcements, companies don’t actually obligate themselves to spend all the cash they authorize. In fact, they may repurchase little or no shares!

Riddle me this:

1. What is one reason why a company may purchase its own shares?
2. Of all the money a company authorizes to be used to repurchase shares, what percentage of it must be used for this purpose?
3. Explain why critics believe a company’s share repurchase announcement is a bad sign.
4. Explain why share repurchases increase earnings per share but not total earnings.

Also known as: Share repurchase.