When a company carries out a share buyback, it acquires a certain number of its own shares, usually on the stock market. Once the shares have been bought back, they are often cancelled, reducing the total number of shares outstanding. The process is governed by strict legal rules to protect shareholders' interests and ensure transparency.

We will therefore focus on share buybacks (also known as "stock pick-ups"), which are the preferred method used by companies (95% of all share buy-backs in the United States, according to a study by Grullon and Ikenberry in 2000).

The impact of share buybacks on the share price (non-exhaustive list):

  • Share buybacks can have a significant impact on a company's share price. The company creates additional demand for its shares on the market, which can help to support or increase the share price.
  • By reducing the number of shares outstanding, share buybacks can mechanically generate higher earnings per share (EPS), which can make the stock more attractive to investors.
  • Share buybacks can also be used to distribute profits to shareholders more efficiently. When the company buys back its own shares, it removes them from the market, reducing the number of shares eligible for dividends. This means that the company's future profits can be spread over a smaller number of shares, potentially leading to higher dividends per share. This would have the effect of pleasing the market, and thus boosting the share price, even if in this case the increase in this ratio is artificial.
  • With fewer shares available to be bought and sold on the market (if the shares are cancelled), from an economic point of view, the reduction in the number of shares outstanding leads to a reduction in the supply of shares. However, demand for the company's shares generally remains unchanged, as investors are still interested in buying and selling the remaining shares. When the supply of shares decreases and demand remains stable, this creates an imbalance between supply and demand, which can lead to an increase in the share price. In other words, the bid/ask ratio is affected in favor of the share price, as there are fewer shares available to buy and sell, but demand for these shares remains constant.

Although share buybacks can have a positive impact on the share price by reducing the supply of outstanding shares and creating an imbalance between supply and demand, it is important to note that this effect is not guaranteed (as is the case for the aforementioned market reaction to share buyback announcements may differ according to investors' expectations and perceptions of the company's financial health, etc...). So we'd need a broader view to really come up with a proper analysis, but this article is dedicated to share buybacks, so let's get back to business.

The reasons cited so far should all have a positive effect on the company's share price. In our analyses, we also take this parameter into account, as it allows us to better understand and nuance certain variations, and incidentally the fine evolution of certain ratios (EPS, dividends...) which would be potentially riddled with share cancellations. Conversely, a large increase in the number of shares over time is a red flag, but that's not what we're discussing here.

S&P 500 and S&P 500 Buyback performance over 20 years (monthly) :

(Source: Bloomberg)

On the other hand, let's take a look at some of the elements that can confuse investors. The company may be using cash and/or debt to carry out a share buyback operation. Does this mean there are no other investments planned? The market may perceive this negatively, taking it as a sign that the company's core business has reached maturity and that it has not found better investments, failing to expand into other markets.

In the final analysis, it cannot be asserted that share buybacks systematically increase a company's share price. The work of Pascal Quiry and Yann le Fur challenges this widely-held belief. They point out that scientific research shows that the impact of share buy-backs on share prices is marginally positive and not very significant. There are several reasons for this discrepancy between fact and public sentiment, including confusion between cause and consequence, regulatory limits on share buybacks and the illusion of earnings per share (EPS). The study teaches us that it's important not to confuse share buybacks with actual company performance. Over a shorter period, but still of long duration, we can already qualify the graph presented above.

S&P 500 and S&P 500 Buyback performance over 10 years (weekly) :

(Source: Bloomberg)

While these impacts may be the main purpose of a company's share buyback, their motivations are often more subtle.

Among the various possible objectives of share buybacks, we can also cite :

Ownership: One of the main advantages of this operation is that it results in increased ownership of the company for the remaining shareholders. As the number of outstanding shares decreases, the proportion of each shareholder to the total number of shares increases. In other words, the relative ownership of each shareholder in the company increases, meaning that they own a larger share of the company. The main purpose of the share buyback could be to increase the power of the major shareholders. For a squeeze-out it is more or less the same thing, being another technique of share buyback. 

Stock options: The repurchased shares can be used to fuel stock option programs for employees, for example, which can help attract and retain talent. But also to better manage conflicts of interest between executives and shareholders by offering stock options to the management team.

Defense against a takeover bid: Share buybacks can also be used by the company as a defense against an aggressive takeover bid. This reduces the number of shares available, increases their price and thus makes the acquisition more expensive for the aggressive buyer. In addition, it can deter the potential buyer by showing the company's confidence in its own value.

Control of the company: A share buyback can allow majority shareholders to strengthen their control over the company by increasing their relative share of the capital. In addition, by reducing the free float (number of shares available to investors), the company can limit the possibility of other shareholders taking control.

Companies with surplus cash can also decide to distribute it to shareholders : When a company has surplus cash which it does not need to use to finance its current activities or investments, it can choose to buy back its own shares. This redistributes surplus cash to shareholders, who can sell their shares back to the company at a generally advantageous price. In fact, share buy-backs, like dividends, represent a means of distributing wealth to shareholders. One of the advantages of share buybacks is that they are generally less costly than dividend distributions. This is particularly true if capital gains are taxed at a lower rate than ordinary income, which is the case in most countries.

So it's hardly surprising that share buybacks have gained in popularity in recent years:

(Source: Visual capitalist)

Optimizing financial structure: Share buybacks can also be used to adjust a company's financial structure, in particular its debt-to-equity ratio. By buying back its own shares, the company readjusts its capital structure and potentially increases its leverage ratio, which can improve return on equity and make the company more attractive to investors.

Market undervaluation of shares: Share buybacks can be motivated by an undervaluation of the share price, when the company believes that its shares are undervalued on the market. It should not be forgotten that management has the advantage of having a detailed knowledge of the company, compared with the rest of the market (which creates an asymmetry of information). "When companies with outstanding businesses and comfortable financial positions see their shares selling well below their intrinsic value on the market, no other action can benefit shareholders as surely as buybacks." - Warren Buffet.

It is important to note that share buybacks are not the only method of increasing ownership of the company by the remaining shareholders. Other methods, such as issuing new shares or acquiring other companies, can also affect the company's ownership structure. Each method has its own advantages and implications. The impact of share buybacks on the share price depends on many factors, and the consequences can vary according to the company's objectives.