Consider the following article.   What is a share buy-back? Some...

Consider the following article.

 

What is a share buy-back? Some pros and cons explained

By Katie Rodwell November 26, 2019

 

Share buy-backs have been a hot topic in the news over the past few months. We take a look at some of the risks and benefits of share buy-backs for investors.

 

What is share buy-back?

A share buy-back happens when a company offers some or all of its shareholders the opportunity to sell their shares - either all or just a portion of them - back to the company. In the second half of the last financial year, ASX-listed companies spent more than $50 billion buying back their own stock - the most for a six-month period in 12 years, according to the Australian Financial Review (AFR).

 

Why would a company buy back its shares?

It may want to change the structure of how it finances its overall operations and growth, using debt (money borrowed) instead of equity (money raised selling shares to investors).

 

Buying back shares can also increase the company's earnings per share, as when the number of shares on issue is reduced, the profit is split between fewer shares, which can help boost the company's share price.

 

Investor website Investopedia states it can also be a strategic move by the management of an organisation who may want to signal to the market they believe the stock to be undervalued.

 

Is a share buy-back a good thing?

The AFR reported in August 2019 that most Australian fund managers agreed companies returning money to investors was a positive move. As an example of a potential positive outcome, there is the possibility the buy-back could boost the share price, which would be welcome news to some investors, albeit only those who chose to retain some shares in the company.

 

However, there are critics who question whether a buy-back really is the best way for a company to spend its money, preferring instead for it to invest in new products and services and future growth opportunities.

 

What are the risks involved with a share buy-back?

There have been some cases of underperforming companies using a buy-back to artificially prop up their share price and fend off takeovers.

 

(Source: https://www.canstar.com.au/online-trading/share-buyback/)

 

How would a share buy-back change the capital structure of a company? What implication might this have for the weighted average cost of capital (WACC) for the company? (4 marks)