What are stock buybacks and why do companies use them?

If you happen to read the Wall Street Journal or other finance journalism, you’ve probably seen stories about companies buying back their own stock. Curious why organizations would buy their own shares? Turns out, buybacks offer a variety of benefits for both companies and shareholders.

Stock buybacks have increased substantially in recent years, both in terms of the number of companies buying back and the total amount invested. Before the turn of the millennium, roughly 30 percent of U.S. firms were engaging in stock buybacks, yet over the past few years, more than half have, according to S&P Global. In 1996, these firms spent less than $200 billion on buybacks, but by 2018, spending approached $1 trillion.

Companies buy back stocks for myriad reasons, although at the end of the day, the aim is to benefit shareholders and the company itself. With economics, supply and demand are crucial. When a company buys back stock, it increases demand for its shares, creating upward pressure. At the same time, as the company purchases stock, it often decreases the number of shares available in the stock market.

Buying back shares can also signal to investors at-large that the company is confident in its position. If internal leaders were worried that a firm’s share prices were set to decline, they likely wouldn’t buy stocks, as doing so would rack up losses.

Often, when stocks are bought back, they disappear, absorbed into the company, resulting in fewer shares outstanding. As a result, shareholders who still own shares may see their ownership increase. Sometimes, companies will keep the shares and then sell them to raise capital.

Meanwhile, companies often want to avoid having too much cash on their books. Generally, investors like to see funds put to good use, not wasted away. Stock buybacks offer companies a straightforward way to use money while adding value to shareholders.