By Nasdaq Global Information Services
There are many ways in which owning shares of publicly-listed companies can generate wealth; most typically it is through stock price appreciation. Two other important forms of wealth generation include dividends and stock buybacks. Highly successful companies can sometimes reach a position where they are generating more cash than they can reasonably reinvest in the business. During the financial crisis of 2008, investors pressured companies to distribute their accumulated wealth back to their shareholders, and this practice has not stopped. Now, instead of traditional dividend payments, buyback strategies are quite popular as they are seen as a tax advantageous way of returning excess cash flow to investors.
Where Do Buybacks Come From?
In the process of conducting business and other related activities, companies generate cash; the strategy surrounding its usage is critical for management and investor success.
Companies can deploy their cash in various ways. One option is to invest in growth opportunities such as research and development, acquisition activity, and general capital expenditures. Another is to return the cash to shareholders via a dividend payment or stock buyback. In the post-crisis economic environment, which has offered fits of uncertainty, companies have increasingly chosen to return their cash to shareholders in lieu of investing in riskier growth-related activities.
Nasdaq’s white paper “Stock Buybacks” explores stock buybacks, often referred to as share repurchases, one of the methods for companies to return capital to shareholders. It includes an explanation of stock buyback programs, their benefits to shareholders, recent market trends for companies executing buybacks, and the implication for investors.
The Mechanics of a Buyback Program
A stock buyback (or share repurchase) occurs when a company purchases shares of its own stock, often in the open market, thereby reducing the number of shares outstanding. A company typically uses cash to fund the purchase, though some companies finance the purchase.
The decision on whether to finance the purchase or to use cash is based on numerous factors, such as the amount of cash the company has in reserve, as well as the state of the lending environment, including current interest rates.
A company starts the buyback process by announcing publicly and to the SEC that it will repurchase shares. The company typically discloses (a) how much stock it intends to repurchase, usually a dollar amount; (b) a timeline for the repurchase, often spanning months or even years; and (c) whether or when it completes any part or all of its repurchase. SEC Rule 10b-18 outlines specific requirements for stock repurchases on the open market including (a) the manner of purchase, which requires that the company purchase from a single broker or dealer on any given day; (b) time and price constraints to ensure fair trading; and (c) volume limitations, prohibiting a company from purchasing more than 25% of its average daily volume on any given day.
Stock buybacks are one of many transactions that a company can execute on their stock. At the same time that it is repurchasing shares, a company may also be issuing new shares via employee equity grants or stock options. It is often the case that share buyback programs are instituted to specifically offset new stock issuance via such grants or options. As a result, it is possible for a company to issue more shares than it repurchases over a stated buyback period.
To learn more, please download the white paper, which fully illustrates the mechanics of stock buyback programs, discusses market trends and how shareholders may benefit, and explains total shares outstanding and excess returns. For more information, contact us and a member of our team will reach out to you directly.
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