Stock buybacks: What you need to know about them

Last Updated: 16. Januar 2024By

In recent months, there have been phases where it seemed like there was a „buyer’s strike“ in the stock market. This was particularly true for stocks in the second stock market segment. However, a very specific group of buyers has been actively buying even in difficult times, providing a certain level of stability.

And here’s what it’s all about: Many companies have recently taken advantage of low prices and valuations to buy back their own stocks. Just recently, for example, Commerzbank and the Swiss ABB Group reported on the current status of their share buybacks. In the following, I would like to explain the details and background of share buybacks in the „Closing Bell“ section.

How share buybacks can affect (or not affect) When a company buys back its own shares and subsequently destroys them (in stock market language, one says less brutally: „withdraws“), this has several positive effects:

Share buybacks ensure that future company profits have to be distributed among fewer shares. Even with stagnant profits, this increases earnings per share. The same effect also applies to dividends: The dividend sum has to be distributed among fewer shares, resulting in a higher dividend yield. Share buybacks also create a higher demand for the corresponding stock on the stock market. If the supply remains constant, the stock price will rise. Shareholders who want to sell their shares can sell them directly to the company, thus not affecting the stock market price. Why companies buy back their own stocks Now let’s take a look at the motives of companies. Why are they buying back their own stocks again?

The company wants to improve its own stock price and show that it considers its own stock undervalued. The company that buys back its own shares wants to keep shareholders happy, as this is a kind of additional payout (in addition to dividends). A „mature“ company can use share buybacks to ensure that despite stagnant profits, earnings per share increase and the price-earnings ratio (P/E ratio) decreases. This makes the stock more attractive again. Share buybacks currently make sense In light of the current crises, not many companies feel like investing billions in new projects. If at the same time, their own market value has dropped by 20, 30, or even more percent due to temporary crises (especially for many smaller stocks), it makes sense to buy back their own shares at „bargain prices“ and remove them from circulation.

This means that in the next upswing, profits will have to be distributed among fewer shares (the valuation decreases). The dividend sum will also be distributed among fewer shares (resulting in higher dividend yields). As shareholders, you benefit from both effects. However, you should never blindly invest in a stock just because the company is a share buyback company.

My practical tip: Pay attention to other factors as well

In many cases, the reasons why a publicly traded company buys back its own shares are positive. However, share buybacks also carry risks: For example, a share buyback program can also be „misused“ – or at least increase risks. This is the case, for example, when the company is short on cash. In that case, the money should stay within the company.

Therefore, choose stocks from companies that manage to strike a balance between share buybacks, dividend payouts, creating sufficient equity, and investing in new business fields. This way, nothing stands in the way of a good overall return.

(Editor’s note: 16.01.2024 at 6:00 pm)