---
title: "Why Do Companies Perform Stock Buybacks?"
description: "What is a stock buyback? Why do public companies perform buybacks? When does this make sense? What does it do for investors?"
canonical_url: https://trendshare.org/how-to-invest/why-do-companies-perform-stock-buybacks
markdown_url: https://trendshare.org/ai/why-do-companies-perform-stock-buybacks.md
published: 2014-07-20
last_updated: 2017-08-28
content_license: https://trendshare.org/about/disclaimer
---
# Why Do Companies Perform Stock Buybacks?

Source: https://trendshare.org/how-to-invest/why-do-companies-perform-stock-buybacks
Updated: 2017-08-28
Investors want to see the values of their investments increase. Usually that
means the underlying businesses grow by getting more revenue or making more
profit on existing revenue. [Better earnings tend to increase the price per share](https://trendshare.org/how-to-invest/earnings-matter-most), so each share is entitled to greater
earnings and is worth more money on its own.

A public company has plenty of financial tools with which it can increase
its value. It has plenty of options for what to do with its profits, too.  [Some companies pay dividends](https://trendshare.org/how-to-invest/why-do-companies-pay-dividends) to
shareholders, to distribute part of their profits to their owners. This keeps
investors happy. Other companies buy back public shares of their company.
Sometimes this technique makes a company more valuable.

## Why Do Companies Sell Shares Anyway?

Any public company—any company of which you can buy shares in the
stock market—has gone through a process known as an *IPO*, or
*initial public offering*. The people who owned the
company—founders and early investors—sell off pieces of ownership
of the company to raise money.

Suppose your family started a maple syrup company in the wilds of Canada.
You've worked hard and built up a business worth $10 million dollars. It'll
take another $10 million to expand your sales into the United States and the
rest of North America. You could raise that money by saving all of your profits
over several years, taking out a loan, or selling off part of the company to
other investors.

There are good and bad reasons for each option. If you decide to go public,
you'll [work with a special type of bank to figure out IPO details](https://www.entrepreneur.com/article/52826): what the company is worth (given
your plans to grow), how many shares to offer, and the right price for the
initial offering. At some date in the future, any investor can use his or her
[brokerage](https://trendshare.org/how-to-invest/what-is-a-discount-stock-broker) and buy a share of your
company.

Suppose you decided to sell a million shares and keep a million shares for
existing owners (you, your family, and your aunt the angel investor).  You
expect the company to be worth $20 million when the IPO is over. You set the
price of each new share at $10 apiece, so you hope to raise $10 million in the
IPO.

After all is said and done, your company has its existing $10 million value
plus the additional $10 million in capital from the IPO. The million shares you
and your family already had are still worth $10 apiece, but there are another
million shares out there worth $10 apiece. The value of the company is now $20
million—existing value plus the $10 million capital—but each share
holds its $10 value.

Now you have to answer to more owners, but you have the $10 million you
wanted to expand your business. Now you can grow your company into a $100
million business with that huge influx of capital.

## What is the Value of a Share to an Investor?

Every share you own of a company represents a right to a share of its
profits. If your maple syrup business brings in a $2 million profit this year
and there are two million shares outstanding, each share is entitled to $1. [Over time, the share price of a stock will reflect the value of the business](https://trendshare.org/how-to-invest/what-is-intrinsic-value). If you can increase that profit per
stock to $1.20 next year and $1.50 the year after that, the price of your stock
should increase.

## How Does a Company Increase the Profit Per Share?

Obviously it's better to earn more profit per share every year. A business can do this in several ways:

- Sell more products or services

- Increase the price of products or services

- Cut costs and keep more profits

- Reduce the number of shares outstanding

## What is a Stock Buyback?

Right now, your little maple syrup company has $2 million in profits with
two million shares outstanding. If you made $4 million in profits with the same
number of shares outstanding, you'd have $2 in earnings per share.

What if you don't have $4 million in profits? You can still get $2 in
earnings per share *by reducing the number of outstanding shares*.
(Stock splits are common. Stock joins are rare. Both techniques change the
number of shares outstanding, but they aren't as interesting in this
context.)

A *stock buyback* is where a business buys outstanding shares of
stock and then cancels them? Think of every share you sold during your IPO as a
strange sort of loan, where you offer a share of profits instead of an interest
rate. When the loan is over, you don't have to pay that share of the profits
anymore. If your business had money and didn't know what to do with it (buy a
new factory, buy a competitor, launch a new line of sugar-free maple syrup, [pay dividends](https://trendshare.org/how-to-invest/why-do-some-companies-not-pay-dividends)), you could
use that money to retire those shares.

Sometimes that makes sense.

## When Should a Company Buy Back Shares?

Public companies have a duty to use their profits responsibly. Buying back
shares makes sense only when that's the best investment the business can make.
If you believe you'll get a better return by expanding into fruit syrups, do
that. If you believe you'll get a better return by investing in a more
efficient factory, do that. If you believe that you'll get a better return by
investing that money in something liquid, so you'll have it as cash reserves,
do that.

Buying back shares is a good approach when the business believes that [its shares are undervalued](https://trendshare.org/how-to-invest/what-is-value-investing) *and*
there are no better ways to grow the business. Overpaying for a share of the
business is as bad for the company as it is for an individual investor.

Not all companies perform stock buybacks, though in the past several years
it's grown more popular. (There are solid economic reasons for this, including
a demand-side recession in the United States.) Sometimes they make sense. As
with any investment, the question of what to do depends on the nature of the
underlying business and what other opportunities it has. An untrustworthy
company can use a buyback to prop up a flailing business or to raise the price
of shares artificially so that corporate officers can unload their stock.
Bloomberg View columnist [Barry Ritholtz](https://twitter.com/ritholtz) provides more details on when and why you might [prefer dividends to buybacks](https://www.theglobeandmail.com/globe-investor/investor-education/why-dividends-are-a-better-bet-than-share-buybacks/article29584070/).

Yet in the right circumstances, stock buybacks represent a relatively cheap
and easy way to increase the value of a stock. Earnings per share go up,
investors see their shares worth a little more, and the business hums along
year after year.