The Pros and Cons of Stock Buybacks for Investors

Public companies often buy back large blocks of their stock typically when share prices are low. During an economic downturn, stock buybacks usually boom. But it’s not always a big plus for individual investors. Here's a look at some of the pros and cons of stock buybacks:

Pros of stock buybacks for investors

• Boost in share prices: Stock buybacks can offer a short-term bonus for investors. The buyback means there are fewer shares trading on the public markets. This tends to strengthen the share price, so your shares may be worth more, at least in the short term.
• Rising dividends: Sometimes the company will be able to increase dividend payment amounts after a buyback because there are fewer shares on which the company must pay a dividend.
• Better earnings per share: When public companies announce profits, they track their progress in part by looking at earnings per share. With fewer shares trading, the EPS number usually rises. This can help the company beat market expectations for their performance and help drive a higher stock price.
• Less excess cash: If a company has bundles of cash just sitting in a money market account, that money isn't doing much for the company. It's earning a very low interest rate, which is a portion of the company's profitable activities. Removing the cash from the company books can lift overall performance.
• Positive psychology: When a company buys back stock, investors usually see it as a sign the company believes the price should be higher, that investors are not realizing the company's true value. This can sometimes kick off an upward swing in stock price.

More articles from AllBusiness.com:

• 5 Strategies for Getting More Money Out of Your Business
• What Is the Difference Between Common Stock and Preferred Stock?
• The Tax Implications of C Corporations
• 10 Questions to Ask Yourself Before Investing

Cons on stock buybacks for investors

• Poor predictions: While the idea is for companies to buy up their stock when it's cheap, often that doesn't happen. After all, who can predict the stock market? Companies often end up buying their stock at what turns out to be high levels, making the buyback a bad use of capital.
• Sinking dividends: Sometimes companies spend a lot of money buying up shares and then cut their dividend as a result. After spending money buying back shares, the company has less cash to hand out in a quarterly dividend. So if you’re an investor who relies on dividend checks for income, this could hit you in the pocketbook.
• Poor use of capital: When a company is spending millions buying their own stock, a savvy investor should ask: Why can't they find something better to do with their money? Every dollar used to buy up stock is a dollar that isn't hiring more employees, ramping up marketing, acquiring a competitor, developing a new product, or otherwise investing that money to grow the business.
• Management self-interest: Stock buybacks often benefit big shareholders the most; and frequently that means company managers who hold stock options. When the buyback boosts the stock price, often temporarily, that rise may help the stock hit a target price the managers need to exercise their options. The managers can then quickly resell their stock and pocket their profits. So company management is enriched, while the company's research and development, marketing, hiring, and other departments are impoverished by the move. Managers may also benefit from a buyback because their bonuses may be tied to hitting a particular earnings-per-share figure. Fewer shares mean a higher EPS number.
• Cover for stock handouts: If a company is issuing tons of stock options to managers, a stock buyback helps counter that by reducing the number of shares on the market. Otherwise investors might see noticeable stock-price dilution. The buyback can help distract investors from the fact that excessive stock handouts are taking place.

FAQs about stock buybacks for investors

Below we have summarized the most important questions and answers on the subject.

RELATED: 4 Reasons to Dump a Stock