Company stock refers to the shares that the company has been authorized when it incorporated and that have been issued for sale. Some company stock is always held by the board of directors, usually to maintain a controlling interest in the business, but other shares are sold to the public in the initial public offering in order to raise capital. However, as the business continues it can change its outstanding stock, increasing the number of shares through a stock split or, at times, decreasing the number of shares by buying stock back from investors.
A stock buyback can occur for many reasons, but many investors talk about it increasing EPS, or earnings per share. After all, if there are fewer shares of outstanding stock present, then more company earnings will apply to each share, effectively raising the value of every share in the EPS ratio. However, a share repurchase does not actually work that way. Companies must pay to buy their stock back, usually through an auction or offering to investors, so earnings decrease along with shares and the effect tends to equalize both sides.
A share repurchase will also change company ownership. The more shares that are outstanding and available to the public, the more investors can buy part of the company. If company owners allow too many shares to be sold, they can increase the chance that a rival could buy up controlling interest in the business and take it over. A share repurchase can decrease the number of shares in public hands but not change the shares held by directors, making it much easier to control ownership.
Capital Structure Changes
Capital structure refers to how the company finances its operations and investments, either through debt or equity. Debt refers to lines of credit, loans or bonds that the company creates, while equity refers to different types of stock that the company has sold to raise money. Buying back shares decreases the amount of capital raised through equity. This may not seem important, but many investors look at the capital structure of a business when considering investment, and in some industries a structure weighted toward equity can be a negative sign.
There is a concept in the stock market known as signaling, which refers to the effects that a stock action has on investors. When a company decides to repurchase shares, it is communicating a message to all investors through how much money it is offering for shares and the reasons it states for the repurchase. If directors hold onto their stock and the company offers high prices for the shares, this can have a positive effect on the stock. Doubt or low prices make a company appear desperate and can hurt stock value.
Why Does a Company Repurchase Stock?
In some cases, a publicly traded company issues a stock buyback or share-repurchase plan. This move signals that the company is going...