Stock buybacks increase a financial metric called earnings per share (EPS), and the increase of the EPS indicates a stock may be undervalued. An undervalued stock has the potential to grow in value; therefore, an undervalued stock becomes more attractive to investors to buy. Stock buybacks create demand, and the demand leads to an increase in stock price.
Tender offer and the open market are methods used when executing a stock buyback. The tender offer is an offer made to the shareholder by the company to purchase stocks. The tender offer will indicate the price range that the company is willing to purchase and the amount of stocks the company plan to purchase. Stock buybacks can also be executed via the open market. With the use of the open market method, the announcement of a stock buyback will create demand that will increase the stock price; therefore, the company will have to pay shareholders the increased stock price.
A stock buyback will also affect the return on asset (ROA) and return on equity (ROE). The stock buyback will increase both the ROA and ROE and both would be good signs for investors. When stock has great ROA and ROE, it translates to a greater demand for the stock. Demand will cause a stock’s price to increase. Since it is evident that the stock buyback can manipulate the stock in manner to make it attractive buy for investors, the investors must be aware of the motives of the company executing a stock buyback.
Many companies will attempt stock buyback for a quick fix of the financial ratios such as the EPS, ROE, and ROA to provide investors the impression that the stock is doing well. Investors must be aware of companies when they attempt to hide the flaws of their stock with stock buyback. In such cases, the lasting affects will only last for the short-term.
A stock buyback can manipulate stock price for the short-term. The announcement of a stock buyback will create enough demand to drive stock price up. By announcing a stock buyback, many investors will think the stock is undervalued. An undervalued stock is an attractive stock to investors. The financial ratios are greatly affected when stock buyback is implemented.
ROE, ROA, and EPS along with the price to earnings ratio are financial ratios that are important to investors who use fundamental financial data to analyze a stock before purchase. When the ratios are positive, it can easily act as catalyst to increase stock price; therefore, stock buyback do affect stock price.