Stock buybacks are a common way for companies to attempt to build shareholder value. In the case when companies have a lot of cash on hand, many will choose to repurchase shares of common stock, which has several positive effects.
Benefits to the company buying back stock
- The purchases reduce the number of shares outstanding. This is good news for investors because fewer shares will earns a higher EPS, which should push stock prices up.
- Purchasing stock back reduces the amount of cash the company keeps on hand. This is important because cash tends to make a company's performance look poor and at the same time makes the company an attractive acquisition target by companies who will then use the cash hoard to help finance their takeover.
- Stock buybacks send a strong signal to Wall Street that the company's management thinks shares are undervalued. This can help the larger market discover the same thing.
- Stock buybacks stimulate demand and generally have a positive impact on the stock price. As more shares are bought back from the open market, the remaining shares tend to rise in value.
- A share buyback will generally cause a positive increase in Return on Equity (ROE). This can help management look good and the stock look more attractive to potential investors.
For companies with a large cash hoard, a stock buyback plan is generally a solid idea because it offers real benefits to investors as well as the company.