Stock Buy Backs

Stock buy backs occur when a company announces they will buy a number of shares from the market. This buying back of outstanding shares is often looked at as a bullish sign and for good reason.

There are three reasons why a company might take this approach.

1. They want to increase the price by buying more shares. This leads to a smaller number of shares on the open market which leads to less supply. In theory this would bring the price of the stock up.

2. To eliminate threats of a shareholder who wants to control the company by buying the majority of the shares. Buying back shares will reduce or eliminate this threat.

3. To invest in themselves. The last reason a company would want to buy back their stock is to invest in themselves.

Stock buy backs are often seen as a bullish sign. It makes sense if a company announces that they will buy back their shares it should mean good things are coming. The company knows itself better than anyone else. If they invest in themselves that means they can’t find a better opportunity elsewhere, this becomes a bullish sign in a similar way that insider trading can.

Studies show that buy backs do outperform the market as a whole by 3%. Even so you should not buy a stock just because they are about to buy some of their shares back. A company could just be announcing it to hide something else or a company might not follow through with the buy backs.

Studies also show that two thirds of the companies that announce a buy back will not follow through completely. They may buy a few shares but nothing compared to what their estimates stated. Some may even decide to not buy any shares back at all.

Regardless when a company announces that they will buy a number of shares back from the open market it will normally have a short term bounce up as investors hear the news. This can offer a good short term play but should not be looked at as a long term indicator.

Doing your research, can help you avoid getting into a bad trades or investments. Always make sure the company is worth buying before putting any money up front.