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What are Buybacks?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 01 December 2016
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    Conjecture Corporation
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The process of buybacks is based on the idea of controlling the buyer’s market that is associated with the stock of a particular company. Essentially, buybacks involve repurchasing outstanding shares of stock as a means of limiting the number of shares that are available for purchase by investors.

As a way of managing the performance of the company’s stock during a soft market, the buyback approach can be very effective. Essentially, a company may choose to engage in a buyback as a means of managing the supply over demand. By limiting the number of shares that are available for acquisition, it is possible to turn a buyers' market into a sellers’ market, at least for the one company. Less available shares may create enough interest that the demand for the remaining open shares that the company can choose to slowly release additional shares to the market, when and as it chooses.

In addition to influencing the buyer’s market, buybacks can also have a positive impact on the company itself. Generally, a buyback will result in putting cash reserves that are doing nothing to work. The effort also usually generates a raise in the earnings generated per share, which is good for both the company and the shareholders. In some cases, the recovered stock can also be converted for use in employee stock ownership plans or as part of a broader pension plan for the employees.

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However, buybacks do not always result in the achievement of the desired result. If the presence of a smaller number of shares does not generate interest on the buyer’s market, then chances are the value of the shares will not increase to any appreciable degree. Instead of becoming a means of increasing the productivity of the cash reserves of the company, the buyback attempt simply ties up reserves that could have been used for some other revenue generating strategy. In order to be worthwhile, buybacks have to occur in a buyer’s market where the recovery of the shares is likely to cause potential investors to desire the remaining available shares and begin to compete for the privilege of acquiring the shares. If this sort of environment does not exist, then it is a much better approach to delay the buyback until the buyer’s market is ready to respond affirmatively to the effort.

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