Why Buybacks Connotate a Rise in Share Prices, Tax Gains and Shareholder Optimism

By: Montana Timpson

Typically, companies can return wealth to shareholders through stock price appreciations, dividends, or stock buybacks. In the past, dividends were the most common form of wealth distribution. As of recent, however, there’s been a fundamental shift in the way companies deploy capital, with buybacks rising as time presses on. For professional traders, buybacks can hold many positive connotations — including a rise in share prices, tax benefits and increased optimism in company stability.

A buyback, also referred to as a “share repurchase,” is when a company buys its own outstanding shares to reduce the number of shares available on the open market. Reducing the number of shares outstanding on the market increases the proportion of shares owned by investors, thereby inflating positive earnings per share and, often, the value of the stock.

Buybacks can benefit investors by increasing earnings per share (EPS), as well as increasing share prices. In practice, buybacks reduce the number of assets on a company’s balance sheet but don’t affect the level of profitability, thus increasing the EPS.

Companies might vie to pursue a buyback program if they believe their shares are undervalued after failing to meet expected earnings which might occur in the case of a weakened market. Companies can choose to repurchase shares and resell them in the open market to accurately reflect the value of the company once the EPS increases. Traders who choose not to sell would then have a higher percent of ownership of the company’s shares and a higher price per share, while those who do would have the opportunity to sell at a higher price.

Buyback Tax Benefits
Buybacks can offer professional traders potential tax benefits, as well. When excess cash is used to repurchase company stock, instead of increasing dividend payments, shareholders have the opportunity to defer capital gains if share prices increase. Traditionally, buybacks are taxed at a capital gains tax rate, whereas dividends are subject to ordinary income tax. If the stock has been held for more than one year, the gains would be subject to an even lower capital gains rate, even under newly proposed tax plans.

Buyback Cash Flow
In addition to increased share prices and tax benefits, buybacks can contribute to optimism in shareholder sentiment. When companies pursue buyback programs, this demonstrates to investors that the company has additional cash on hand. More importantly, it signals to investors that the company feels cash is better used to reimburse shareholders than reinvest alternative assets. In essence, this supports the price of the stock and provides long-term security for investors.

For more details, check out Lightspeed’s Trading Education Center, featuring a comprehensive glossary for professional traders. For additional references, guides and resources, view our Active Trading Blog and register now for our next live webinar.

Active Trading with Lightspeed
Lightspeed provides professional traders with all the tools required to help them find success in stock trading, and we have been developing and honing our active trader platform to offer an optimal user experience. With the intuitive interface layouts and institutional quality stock and options scanners, we aim to help traders reach their goals, no matter what their strategy is. We also offer our clients some of the lowest trading fees in the industry.

For more information on a professional trading platform with Lightspeed, please call us at 1-888-577-3123, request a demo, or open an account.

Data, information, and material (“content”) are provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities or contracts. Any investment decisions made by the user through the use of such content are solely based on the users’ independent analyses taking into consideration your financial circumstances, investment objectives, and risk tolerance.

You may also be interested in...

Bank Stocks Kick Of Q3 Earnings Season With A Bang
Read More
The IPOX® Week, October 18th, 2021
Read More
4 Bad Habits That Stock Traders Should Break
Read More
Understanding the Difference Between Option Volume and Open Interest
Read More

Try the demo

Compare Platforms
Check the background of this firm on FINRA's BrokerCheck

Our website uses cookies to improve the performance of our site, to analyze the traffic to our site, and to personalize your experience of the site. You can control cookies through your browser settings. Please find more information on the cookies used on our site in our Privacy Policy. By clicking OK, you agree to allow us to collect information through cookies.