ELI5: Stock Buybacks

Stock buybacks have been in the hot seat. Companies of all shapes and sizes are facing criticism for their "excessive" buyback programs.

Today we breakdown what buybacks are and if they're really as bad as people say.

What is a Stock Buyback?

A stock buyback is exactly what it sounds like. A company buys back stock. Also referred to as a shares repurchase. Done either by tender offer or in the open market.

A tender offer is a proposal to shareholders which outlines the number of shares a company is willing to buy and the price they are willing to buy for. Shareholders can either accept or decline. There's no obligation on their end.

More commonly, a company will simply repurchase shares in the open market.

Why Would a Company Buy Back Their Own Stock?

When companies have excess cash, buybacks are a way to distribute wealth to their shareholders. Buybacks reduce the number of outstanding shares, driving prices up and increasing shareholder value.

Another common way to distribute wealth is paying dividends. People loves dividends but buybacks are actually much more efficient as they don't trigger immediate tax consequences.

What's the Big Deal?

A lot of the critics believe repurchasing shares reduce innovation and economic investment. They argue, instead of buying back stock, companies should be spending on acquisitions, research, new projects and hiring.

Despite the criticism, there's little evidence suggesting any negative economic impact.

So Are They Bad?

Stock buybacks are simply a way to distribute wealth to shareholders. If companies determine there is no better use for their excess cash, it's better to give it to your shareholders than to invest in bad projects for the sake of it. Buybacks are just a tool, not good, not bad.

"Buybacks are divisive, they divide people who do understand finance from people who don't" - Professor Kenneth French

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