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Buy back stocks: Meaning, advantages & disadvantages.

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Meaning of buy back stocks

Buyback stocks is a process where companies repurchase its stocks from stockholders or open market. This is generally considered to be a good sign as it is one indirect way for companies with surplus cash to maximize the wealth of its stockholders.A company with surplus cash prefer to buy its stocks when current market price of stocks is less than book value or what they expects it to be. Companies buy their stocks at a premium price and this leads to increase in stock price.

Possible reasons for buyback are discussed below:

1) To increase stockholders value as company uses its surplus funds which is not suitable for any investment options it results in higher earning per share.

2)For protection against corporate takeovers. Buyback helps in increasing the promoters holding thereby reducing the chances of takeover.

3)To improve financial ratios as buyback reduces the cash component on companies balance sheet.


Advantages of buyback :

1)Companies which have profitability less then there average industry witness more price growth after repurchase of stocks than those who are having profitability more than their average industry.

2) Buyback of stocks promotes a positive message among its stockholders and they gain more confidence in company's performance as they believes if management is buying back their stock then they are sure for their good future performance.

3)Surplus cash which is not being used for some productive use is used for buying back stocks. It helps in making effective use of excess cash as idle capital will not help in bringing any income.

4) Stockholders who sells their stocks in repurchase programme have an opportunity to get current market price + premium as companies buyback their stocks at a premium amount.

Disadvantages of buyback :

1) Excess cash is used for buying back, it includes opportunity cost as well which signifies that company is neglecting opportunities like setting up new plant, increasing human resource, improving sells and more for it.

2) A company may have wrong intention of increasing their stock price and further selling them at high price. Therefore traders should check about company's history and learn if they have done something like this in past and what were their intentions to do so.

3)Stockholders may think that company is unable to perform well and is not finding any new business opportunity therefore it is using there excess cash for this purpose.

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