Part 1: What is a Stock Buyback, Example, Types of Stock Buybacks, Impact on Existing Shareholders
Part 2: Rationale / Why a Company Buys Back its Stock, What is Done with the Bought Back Stock
Introduction to Stock Buybacks for Kids and Teens
This video explains the concept in a simple, concise way for kids and beginners. It could be used by kids & teens to learn about share buyback, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.
Suitable for students from grade levels:
- Elementary School
- Middle School
- High School
The topics covered are:
- What is a Stock Buyback
- Example of Stock Buyback
- Different types of stock buybacks
- Impact of buybacks on existing shareholders
- Why does a company buy back its own stock
- What does a company do with the stocks it buys back
- Which kinds of companies do stock buybacks
What is a Stock Buyback?
A stock buyback, or share repurchase, is when a company buys shares of its own stock back from its shareholders.
This decreases the number of outstanding shares of the company but increases the shareholder value, as each remaining shareholder now holds a larger proportion of the outstanding shares.
Example of Stock Buyback – Can you give me an example?
If a company had 100,000 shares outstanding, a shareholder who has 100 shares owns 0.1% of that company.
If the company bought back 20,000 shares, a shareholder with the same 100 shares would now own 0.125% of that company, a 25% increase in shareholder value simply due to a reduction in the number of outstanding shares.
This is also usually accompanied by a corresponding increase in the stock price.
Are there different types of stock buybacks?
There are 2 main types of stock buybacks.
A Tender Offer is where a company offers its shareholders a chance to submit or tender all or a portion of their shares within a predetermined price range. Shareholders who accept the offer specify how many shares they are willing to sell and at what price. After receiving all the offers, the company decides the final price and the number of shares to buy back.
In an Open Market stock buyback, a company buys its stocks from the open market – just like an investor would do – at the prevailing market price. This is done after the company makes the buyback announcement.
How does a buyback impact existing shareholders?
When a company announces a stock buyback, the stock price usually goes up. If you own stock in the company, you can participate in the buyback or sell the stocks in the open market, and profit from the increased stock price.
If you retain your stock, you can benefit from the future growth of the company.
Why would a company buy back its own stock?
When the company has excess cash, a stock buyback is a way for the company to invest in itself and reward its shareholders, as fewer outstanding shares help increase shareholder value. Stock buybacks also make a company look more attractive to potential investors by improving financial ratios without any increase in earnings.
For example, as the number of outstanding shares reduces, the Earnings Per Share or EPS automatically improves since the same earnings are spread across fewer shares. Reduction in outstanding shares improves Return on Equity (ROE), and the reduction in cash improves Return on Assets (ROA).
Another reason a company might do a stock buyback is if it thinks its stock is undervalued. For instance, the company can buy its own shares at a low price, and once the stock price goes up again, reissue the stocks at the higher price.
What does a company do with the stocks it buys back?
The company either destroys the stocks it buys back, or holds onto them as treasury stocks that can be reissued later.
Which kinds of companies do stock buybacks?
Any company can do a stock buyback.
But usually, well established blue chip companies that have excess cash are the ones that buy back stock. Check out our video on blue chip companies to learn more.