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Buyback programs not always great news for shareholders

Provided by RBC Wealth Management
and Dave Dupont

In a stock buyback program, a company buys back shares of its stock from the marketplace. This ultimately reduces the number of shares, making each share worth more. So if you’re a shareholder in a company that announces a stock buyback program, theoretically you’ve benefited. But there are reasons to remain cautious.

First, even if a company authorizes a buyback program it doesn’t mean it will follow through with the plan. The authorization simply means the company has the right to buy its shares back in the future. It’s not a guarantee that the buyback program will happen.

There’s also the question of the company’s motives. In some cases, a company may buy its shares in order to issue employee stock options. If this is the case, keep in mind that stock options have the opposite effect of share repurchases — when exercised, they increase the number of shares outstanding rather than reduce them.

A company might also be looking to offset outstanding employee stock options. For example, let’s say a company announces it will buy $1 billion of its own stock. If the company is valued at $50 per share, $1 billion is equivalent to 20 million shares. However, if the company has 25 million shares in outstanding employee stock options, it could still see diluted earnings.

Another consideration is whether the company is looking to increase value for its shareholders, or simply improve its own financial ratios. Since buybacks reduce the number of shares, they can subsequently help a company increase per-share earnings.

While not all stock buyback programs are in the best interest of the shareholders, there are still good reasons companies decide to initiate a buyback. In some cases, management may feel its stock has been overlooked, or is undervalued. A stock buyback program can send the message the company believes it is worth more, and thus, wants to invest in itself. This can be viewed as a positive sign.

The problem for shareholders is you can’t always be certain what a company’s motive is because companies don’t need to give details on stock buybacks. However, you can become a more-informed investor by researching the companies you hold a stake in.

This article is provided by Dave Dupont, a Financial Advisor at RBC Wealth Management. RBC Wealth Management does not endorse this organization or publication.

RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC

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