A buyback is when a company can “buy back” their own stock. It is also referred to as a share repurchase, stock repurchase or share buyback. In the past twenty years, the incidence of stock repurchase has risen significantly. In 1980, it was approximately $5 billion and then in 2005 it jumped to $349 billion. A buyback will give cash back to the company’s existing shareholders and in return the company will regain some of its outstanding equity. So, simply put, the cash is given in exchange for a reduction in the number of outstanding shares. The company will either decide to retire the shares or it may keep them as treasury stock and make them available to be reissued at a later date.
There are several reasons why a company would want to initiate a buyback. When a company has a profit, it will generally have a couple of uses for those profits. The profits will be used to pay the shareholders. These payments are called dividends. The rest of the profits stay within the company and is called stockholder’s equity. These funds will be used to reinvest as the company sees fit in the future.
Another reason is that profits may not be high enough to distribute to shareholders. Companies may want to keep a portion of the earnings rather than share with shareholders because they may be embarrassed that it is a reduction from the previous dividend. Most shareholders would prefer a postponement of dividends then received a reduced dividend amount.