Stock Repurchase

Companies sometimes buy back their shares from the open market as a way to increase shareholder value. Distributing dividends is another way of giving value back to the shareholders.

When the board of directors decides to initiate a stock repurchase program, it authorizes a maximum dollar amount of shares or maximum number of shares to be bought back. The target price per share will not be disclosed but it should be close to the recent trading price.

However, just because a stock repurchase plan is announced does not mean that it will be carried out. If the price is not right, like any other investor, the company will not proceed with the buy back.

How does shareholder value increase?

Firstly, the act of reducing the number of available shares in the market should cause the stock price to rise as basic law of supply and demand would suggest.

The more impactful effect of share buy-backs on stock price is the result of the indirect boost to the earnings per share number - an important metric for stock valuation. The following example illustrates this process.

An Example

During the past year, XYZ company booked $10m in profits in which $1m is from interest earned off a $40m cash hoard. The company has 10 million shares outstanding, giving it an EPS of $1 and with a current market price of $20, the stock has a P/E ratio of 20.

The company then announced that it would buy back $40m worth of its own shares  Let us assume it is able to buy them at the current market price of $20 and with $40m, the company proceeds to retire 2 million shares.

Assuming no growth in earnings, the company will earn $9m (less the $1m interest income) the following year. With only 8 million shares outstanding, EPS will have grown to $1.13. If the P/E ratio remains at 20, then the stock price should appreciate to $22.60.

Which companies are likely to buy back shares?

Stock repurchase programs are likely to be announced by mature companies whose management feels that the stock is currently underpriced.

Mature companies possess the capability to generate, or have already generated, large cash surplus. Younger companies typically need to reinvest any excess cash to expand the business.

So instead of distributing dividends, management may decide that buybacks are a superior way to distribute value back to the shareholders.

You May Also Like

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

Follow Us on Facebook to Get Daily Strategies & Tips!

Options Basics

Futures Basics

Bullish Strategies

Bearish Strategies

Neutral Strategies

Synthetic Positions

Options Arbitrage

Options Strategy Finder

Outlook on Underlying:

Profit Potential:

Loss Potential:


No. Legs:

Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.

General Risk Warning:
The financial products offered by the company carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.

Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2017. - All Rights Reserved.