Does a Share Buy Back Fundamentally Increase the Price of a Stock?

by Jake Costa

    In April 2013, Apple announced a $60 billion share buyback, the largest in history. It saw its stock price jump 5 percent in after-hours trading, according to the Los Angeles Times. In a story by MarketWatch, several market commentators gave the buyback much of the credit for the rebound in stock price. But a buyback is no guarantee that a stock will climb. Investors should be aware of other factors that can influence share price.

    A stock buyback is the acquisition by a company of outstanding shares of its own stock. It can do this either buy purchasing shares on the open market like any other investor, or it can make a “tender offer” to shareholders to buy their shares at a prearranged price -- typically representing a premium over the market price. When shareholders sell shares back to the company, it reduces the number of shares outstanding.

    Companies have a number of motives for buying their own shares. If the company offers employees stock options, reducing equity held by outside shareholders can help prevent “dilution.” Since each share represents a claim on a company’s assets and earnings, issuing stock to employees reduces or “dilutes” the fraction of ownership represented by each share. Buying back shares on the open market can counteract dilution. A stock buyback is also a way of returning money to selling shareholders in a way that can be more tax-advantageous than dividends, according to Forbes.

    Because buybacks reduce the number of outstanding shares, they increase earnings per share. By increasing the amount of earnings each share represents, a buyback exerts an upward pressure on the price of the stock. But stock price is influenced by more than just the number of shares on the market, including measures such as earnings expectations, according to Businessweek.

    A stock buyback may even be a negative signal to the investor community, according to CFO.com. A management team that deploys excess cash on stock buybacks implies that the company lacks other opportunities for profitable expansion, such as entering new markets, hiring additional staff, or investing in research and development. External events that affect the broader market could also weigh on a stock's price. A company might also choose to fund a buyback by taking on additional debt (as Apple did), increasing the debt-to-capital ratio. Any of these factors might have a greater impact on share price than a stock buyback.

    About the Author

    Jake Costa has been a reporter and editor since 2003. Among other topics, he has covered business, finance, science, technology and the environment. He has written for "The Financial Times," Environmental Leader, "Latin Finance" and Sybase. He has a Bachelor of Arts in literature from the University of Michigan.

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