WHY STOCK BUYBACKS CAN EITHER BE GOOD OR BAD

Stock buybacks are when a company spends its excess capital to buy back shares of its own stock. Investors generally consider buybacks a good thing because it can signal that a company is confident in its future and sees no better investment than itself.

Publicly held companies have these choices when it comes to spending profits:

1) Offer dividends to investors - dividends are a way to directly funnel profits to investors.
2) Do a stock buy back - stock buybacks can indirectly make investors money because the stock price might go up as the company buys shares.
3) Use the money for research and development - using the money for R&D is an investment in the future and will hopefully pay off at a future time.
4) Buy other smaller companies - buying another company is something that can make the buying company stronger by adding new technology and new products.
5) Sit on the money and invest it - keeping the money and investing it is something that might add security to the company as they build savings that could be used to keep the company afloat in tough times or be used in any of the above ways later.

Stock buybacks have become popular in recent years (you can get a current list of announced buybacks here) and the biggest one on record is Apple's buyback. Anything Apple does gets a ridiculous amount of scrutiny so there are a lot of opinions rattling around the Web. But with all those opinions you can sift through and sometimes find the truth and that truth is that a buy back can turn out to be a good thing or a bad thing.

Stock Buybacks Can Be Good

When a company spends its own money buying its own stock, it might show that management is confident in the future (after all they know best whats in store in their pipeline of products). They feel that there is no better investment out their than their own stock so that is a vote of confidence that many investors like. 

Also, when a company does do a buyback, that means there will be shares bought and that will/should/can help drive up the price of the stock. This will of course depend on the number of sellers but having guaranteed buyers is a good thing. So, investors may profit from a buyback by seeing their shares appreciate in value.

But, Stock Buybacks Can Also Be Bad Because...

When a company buys back any amount of its shares on the open market, they are paying the same price you or I would if we bought the stock. So if they pay a hypothetical average price of $100 per share and after they do that the stock goes down and continues going down, it sure looks like they paid too high a price. That is bad. Just like investors can buy stocks at too high a price and get burned, so can companies who buy back their own stock. Figuring out what the correct value of their company is and making sure they pay a price that is lower than that is key for management.

Another reason a stock buyback could be interpreted to be a bad thing is if investors decide a company is doing a buyback because they are out of ideas for better ways to use the cash. Remember, investors are always looking for businesses that are growing so they can make more and more money. That is why R&D and M&A are often considered good ways to spend money - it shows that company management is thinking forward and trying to grow the business. Just buying back their own stock could indicate a lack of new direction which might in some instances be viewed by investors as bad.