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Why Do Companies Do a Stock Buy Back?

Following the stock market isn’t always easy. There are a lot of things that you need to know that can affect the price of a company’s stock.

One of those terms is when a company buys back its stock. It can make owning shares a little more complicated than you’d like. Stock buybacks happen almost every day. Google’s parent company Alphabet just announced it will buy back about $25 billion in stock.

Do you want to know how a stock buy back works and how it can impact your stock shares? Read to learn what stock buy back is and why companies do it.

What Is a Stock Buy Back?

A stock buy back is also called a company repurchase or a share repurchase program. It’s when a company buys back its own stock.

This is often seen as a sign that the company is healthy. It means that they have a lot of cash on hand to spend at that moment. Think about it, there are a lot of things that smart companies would do with a lot of cash. They can payout dividends, invest in product development, purchase a larger property to fuel growth, hire employees, pay off debts, and more.

Companies that buy back stock already have already made the critical investments in company growth. When a company buys its own stock back, they often do so out of optimism. They believe that the stock that they have is undervalued.

The Problem with Too Much Cash

Companies can often be a victim of their own success. Investors will have much higher expectations of company earnings each and every quarter. One missed estimate could throw a company stock into turmoil.

A stock repurchase can pay off investors rather than pay dividends. This can be a better option.

The reason why companies go public is to raise money. They exchange a certain amount of money for a piece of ownership in the organization. In reality, a company like Google can have thousands of owners in the form of shareholders.

These shareholders have a say in the direction of the company. They can use their shareholdings to have a right to vote on the overall direction of the company. Too many owners can get in the way of company growth, so companies will often buy back stock to lower the number of actual owners in the company.

For businesses that own their respective industries, they may find that they are close to hitting the ceiling for growth. That means that they’ll have to figure out a way to continue to grow. If they have too much unused cash lying around, it won’t look good to stockholders.

How to Find Companies That Buy Back Shares

This year seems to be the year of the stock buy back. If you want to find out how to make money as an investor, you need to do your homework.

First, you’ll have to find companies that announced a buyback of shares. These companies will usually announce it publicly and file the appropriate paperwork with the SEC.

There is something called a Buyback blackout period, which is an official period from a few weeks at the end of the quarter to 48 hours after the quarterly earnings report.

During this period, company leadership will not announce a share repurchase. After the blackout period, though, it’s fair game.

Investors keep a watchful eye on this blackout period to try to time the buying and selling of stock. They want to take advantage of the stock repurchase. This type of investing can lead to market volatility that you may have to ride out.

What to Watch Out for as an Investor

If you’ve invested in a company that just announced a stock buy back, you should celebrate. You’ll see a nice bump in the stock price as investors try to hop on the bandwagon.

A stock buyback will also create more demand for the stock in the long run. This is the basic law of supply and demand. The more stock that’s available for purchase, the lower the demand.

A stock buyback limits the number of stocks available for public purchase, which will increase the demand for the stock. With increased demand comes higher prices.

While that’s all excellent news for investors, you have to see how the company is financing the stock buyback.

In some cases, companies will finance with cash on hand. This usually isn’t an issue with stock buybacks.

Where you have to keep a close watch is when companies finance their stock repurchases. This financing could hurt the company’s credit rating. It can be a tax-advantage because the interest on the loan can be deducted come tax time.

At the same time, this could be a negative for the company if it carries debt and the stock market tanks or there’s an economic recession.

Companies Can Leverage a Stock Buy Back

Overall, a stock buy back can be a very positive thing in the life of a public company. It can be a great thing for you as an investor, too.

If you invest in the right companies, you can reap the benefits of stock ownership and make a profit. That’s a great way to make your money work for you.

Not all stock buy backs are golden parachutes, though. You have to look at the details of the transaction. You want to make sure that the company is in good health overall and isn’t hiding potential growth issues by repurchasing stock.

As always, you want to do your due diligence before getting too happy about the transaction.

Do you want more tips to better manage your finances? Check out the Business and Finance section for more great articles.

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