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Answer:
Dear
Tom,
Buybacks
on the rise
You're
right. Buybacks are up. According to figures just
compiled by Trim Tabs Investment Research, a record
number of companies (1,012 in fact) bought back their
own shares last year. The total worth of all buybacks
was about $456 billion.
Breaking
that down further -- buybacks for Standard & Poor's
500 companies came in at an estimated $315 billion
-- also a record figure.
The
good news
On
the whole, this translates into good news for investors.
That's because when companies buy back stock, they
wind up reducing the number of shares outstanding
yet the profits are the same. Bottom line: the earnings
per share (EPS) rises, with each investor owning a
larger portion of the profits.
There's
an unwritten assumption in this process that the stock
of a buyback will rise in price. This often occurs
but is by no means guaranteed.
How
it happens
There
are two ways a company can purchase shares of its
stock held by the public.
One,
it can tender an offer to shareholders to buy up to
a stated number of shares at a stated fixed price.
The fixed price is typically higher than the current
market price.
Two,
it can buy back shares in the open market, over a
longer period of time. (With the tender offer, there
is a time limit.)
Why
it happens
There
are a number of reasons why a company buys back its
shares.
-
It thinks its stock is too cheap and undervalued
by the market. A buyback sends a message of confidence
to its competitors as well as to the public. The
message: we have so much faith in our company that
we're buying our own shares.
- Buybacks
may also take place when a company has a large amount
of cash on hand. It could put it back into the company,
say in research and development. It could pay shareholders
a dividend. It could make an acquisition. Or, it
could buy up outstanding shares.
- Another
reason is that the company wants to cover a large
employee stock option program.
-
Or, it could be to protect itself from a takeover.
The more shares off the open market, the more difficult
it is for someone to take over the company.
The
tax benefit
Buybacks
also come with a tax benefit.
When
a company uses its cash to buy back shares -- rather
than using it to pay a dividend -- the company is
actually giving money to its shareholders without
triggering a tax bill for them.
To
be specific, the key tax advantage of buybacks over
dividends is that buybacks are taxed at a lower capital
gains rate whereas dividends are taxed at one's ordinary
income tax rate.
Having
said all this, don't jump on the bandwagon just because
a company is buying back its shares. Make sure it
is well managed, has increased profits and is not
buying back shares to make its various ratios look
stronger.
If
you need more information, feel free to write in again.
Good
luck!
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