Can share repurchase elevate the share price?
A share repurchase means that a public company buys back its issued shares from the market
Two common types of repurchase: direct repurchase and offer repurchase
Public firms repurchase their shares for a variety of reasons, including to raise the stock price when undervalued, to resolve the crisis caused by hostile takeover or merger, to give shareholders a better return, and to optimize the capital structure
When a share repurchase is executed at the right price with good timing, it may lift the stock price, but not for certain. Investors still need to do an in-depth analysis before buying the company's shares
Understanding a share repurchase
We often see the term "share repurchase" in financial news. What does that mean? It refers to the move of a public company to buy back its issued shares from the market.
There are several ways available for companies to do so, and the most common one is to buy back directly from the market.
Listed firms also tend to repurchase their shares through a tender offer. The company will decide how many shares to buy at what price within a given time frame. If the market offers more shares than it wants, then the company will repurchase proportionally. In the opposite case, the company will adjust the price and the time frame.
When shares are repurchased, they may be canceled and reserved for later use (employee benefits, for example).
Why does the company execute a share repurchase? Here are some reasons.
1. If the company feels that its stock price is seriously undervalued, it may consider repurchasing shares to raise its price. According to Buffett's letter to shareholders of 2020, Berkshire will buy back its stock only if Charlie Munger and Buffett believe that it is selling for less than it is worth.
2. The company may also consider a share repurchase to resolve the crisis caused by the hostile takeover and merger. Exxon Mobil Corporation's repurchases in 1989 and 1994 are cases in point.
3. A buyback may give shareholders a better return. Because a repurchase will reduce the number of shares held by the public, earnings per share increase the same profit. Each shareholder gets more dividends when the company provides the same annual total dividends.
4. A share repurchase can also optimize the capital structure. Strong, steadily growing companies may use leverage to repurchase shares. As a result, some related financial indicators will be improved.
When the share repurchase is executed at the right price with good timing, it often sends a positive signal to the market, which may lift the stock price.
The interpretation may include that the company feels the price is undervalued, the company's management cares about shareholders, or the company is taking back control of itself.
On MAR 22, 2021, $Applied Materials(AMAT.US)$ announced a $7.5 billion share repurchase. Its stock price rose about 20% in the following 9 trading days.
In some situations, the result may be worse. For example, the company has big negative news, is in an unhealthy financial position, has difficulty in expansion, or attempts to manipulate its stock price.
In the first half of 2018, $McDonald's(MCD.US)$, $Bank of America(BAC.US)$, and $JPMorgan(JPM.US)$ took billions of dollars to execute share repurchases. But their stock prices didn't show signs of recovering in those six months.
Therefore, a share repurchase does not necessarily lead to a rise in the share price. We need to analyze rationally before investing.
The information contained herein is for educational purposes only. Nothing discussed should be considered investment advice.