Treasury Stock Method – Buying Them Back vs. Retiring Them
When a company purchases back its own stock there can be several reasons for doing so. In fact, when this happens there can be a number of implications for the business as well as for its employees and shareholders, including ways in which the company is valued as well as how the shares are valued.
Reasons for Treasury Stock
As mentioned above, there are a few standard reasons why a company uses the treasury stock method of buying back its own stock. They may feel that there are too many shares in the market and buy some back in order to increase the price of the stocks being sold. The company may also opt to buy back shares in order to prevent a takeover, for example to prevent someone else becoming the majority shareholder. They may also want to issue stocks to employees as an incentive or benefit. There are other reasons, but they are typically more obscure.
Why Stocks Become Undervalued
The most common and simplest reason that stocks lose their value is that there are simply too many shares and not enough demand, but there are a variety of other reasons as well. The price of a stock may fall if a company announces bad news, if they are an overlooked company, if the market becomes over-inflated, when one part of the company is having trouble even if the other departments are fine, if the stock is over-hyped but doesn't perform like expected or if the company is simply in a down-swing.
When to Buy Back Stocks
In the treasury stock method or methods mentioned above, some catalysts that cause stocks to plummet or decrease in value are only temporary. It would be unwise for companies to buy back their own stock every time it took a slight down turn! But when a stock has been steadily decreasing or when it has reached the lowest price it has sold for, it may be wise to consider purchasing back some of the shares.
How Companies Buy Back Treasury Stock
When companies buy back stock off the market they are essentially giving cash to existing shareholders in exchange for some of the company's equity in the market. In other words, the company is essentially buying stocks back from shareholders in order to reduce the shares of a stock that are in the market.
What the Company Does with the Shares
When a company chooses the treasury stock method of buying back these shares, they are bringing them back in-house. They typically have one of two options: they can retire the stock altogether, or they can hold on to it and issue it to employees. When stocks are retired, this means that the shares are no longer in the marketplace, effectively reducing the overall number of shares offered of a company's stock. When the business decides to hang on to the stock, they may use it as incentives or bonuses for employees, giving them a piece of the company that will hopefully soon appreciate.
Whether companies decide to either retire or hang on to treasury stock, they are essentially able to control, to a certain extent, the number of shares in the market and reduce that number if they need.