Many investors like to buy shares in companies that are repurchasing their own shares. The idea is that as a company does this, it reduces the number of shares outstanding, so that each share owns a larger part of the company. However, this strategy has had mixed results. Often, companies buy back shares at the top of a cycle or in lieu of making other, more profitable investments. Companies may also buy back shares to conceal the fact that it is issuing shares to its executives: the issuance and the buyback cancel one another out so you don’t see it in the share count.
So, in what follows, I have pointed out four things that investors should look for when they are analyzing a company that returns capital to shareholders through share buybacks.
1. The company is reducing the number of shares outstanding
As I just mentioned, there are some companies that buy back stock in order to hide the fact that it is issuing stock to executives. Now it isn’t necessarily a bad thing when companies issue stock options to its executives. In many cases, these executives are extremely talented individuals who deserve to be compensated for their work. But there are some cases in which they use the corporation’s funds as their own. So one thing to look for in a buyback is that it works — that is, it reduces the number of shares outstanding meaningfully. Each quarter/year the company reports the average number of shares outstanding for that quarter/year. If the number goes down consistently and meaningfully, you have company that is rewarding long-term shareholders with buybacks.