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How Do Stock Buybacks Work?

A Balanced Look at Stock Buybacks

Part 1: How Do Stock Buybacks Work?

Stock buybacks (i.e. a company repurchasing shares of its own stock) have been targets for praise and criticism through the years. So, are they good or evil? We agree with The Wall Street Journal columnist Jason Zweig, who once wrote:

“Buybacks are neither bad nor good. They are simply a tool. Just as you can use a hammer either to build a house or knock one down, buybacks are useful in the right corporate hands and dangerous in the wrong ones.”

In other words, a stock buyback can help you, hurt you or be a neutral event, depending on the particulars. Today, let’s embark on a balanced look at stock buybacks.

Big Picture: Diversification Is Still Our Best Friend

Before we dive into any details, let’s answer a bigger question. No matter how you may feel about stock buybacks, what should you do about them as an investor? If you are familiar with our general investment strategy, our answer will come as no surprise:

Stock buybacks give investors yet another reason to prefer widely diversifying their investing across myriad asset classes around the world, rather than trying to get ahead by deliberately picking or avoiding particular stocks or industries.

As with any stock bid, even a well-devised buyback can backfire if the future does not unfold as hoped for. It can be even worse if the buyback motives were shaky to begin with. Because we cannot predict, we advise investing across a globally diversified portfolio of low-cost mutual funds or ETFs, using fund managers who avoid engaging in market-timing or stock-picking. That way, you will continue to capture long-term market growth, including any returns generated by stock buybacks, without needing to assess each one as it occurs.

In this context, let’s look at how buybacks generally work. Even if you are not actively participating in individual stock buybacks, it is worth being informed about them, especially if you are employed at a company that may periodically offer them.

How Do Stock Buybacks Work?

In general, you and other traders can buy or sell any publicly traded stock on an open exchange like the NASDAQ or New York Stock Exchange (NYSE). Similarly, a company can participate in these same exchanges, using its retained earnings to buy back or extend a tender offer to repurchase some of its own stock.

However, just because a company wants to buy back shares, does not mean you have to sell any of yours. A stock buyback offer is just like any other trade on the open market. Before a trade occurs, would-be buyers and sellers must agree on a fair price. (1)

There is also one noteworthy difference between a stock buyback versus simply selling stock to another trader. In a “regular” trade, one of you is the seller, and the other is the buyer. End of story. But when you own a company’s stock, you own a piece of its capital, making you a co-owner. Thus, in a stock buyback, you may have vested interests on both sides of the trade.

And that is where things get interesting. How do companies use (and occasionally abuse) stock buybacks to deliver sustainable value to its shareholders? We will explore that topic in our next piece.

FREE FINANCIAL ASSESSMENT

With all the uncertainty and volatility in today’s economy, the time is now to take a thorough look at your finances. To accurately plan for your financial future, you must first know where you currently stand. For these reasons, our Success Team at Impact Advisors Group is offering a free financial assessment for both individuals and business owners. Request yours today!

This post was written and first distributed by Wendy J. Cook.

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Impact Advisors Group LLC (“[IAG]”) is a registered investment advisor offering advisory services in the State of Massachusetts and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal any performance noted on this site. The information on this site is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Impact Advisors Group disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose. IAG does not warrant that the information on this site will be free from error. Your use of the information is at your sole risk. Under no circumstances shall IAG be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided on this site, even if IAG or a IAG authorized representative has been advised of the possibility of such damages. Information contained on this site should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.
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