What is a Buy-Back?

A buy-back is when a company or government buys back its own stuff that it previously sold to people. There are two main types of buy-backs: share buy-backs and bond buy-backs.

Share Buy-Backs

With a share buy-back, a company buys back its own shares of stock from shareholders. The company pays cash money to shareholders and takes back the shares. Now the company owns more of itself.

Companies do share buy-backs for a few reasons:

They think their stock price is too low. Buying shares raises the price. Buying shares makes earnings per share go up, without the company actually earning more money. They have extra cash and nothing better to do with it. Shareholders get cash without the company paying taxable dividends.

Here’s how a share buy-back works:

1. The company announces it will buy back a certain number of shares at a certain price range within a certain time period. This announcement often makes the stock price go up right away.
2. The company buys shares slowly over time, usually from the open market. Sometimes they buy chunks of shares directly from big shareholders instead.
3. As the company buys more shares, the stock price tends to go up. Supply and demand.
4. Earnings per share (EPS) goes up, even if the company didn’t actually grow earnings. That’s because now earnings are divided among fewer shares.
5. Eventually the company finishes the buy-back program. Shareholders have more cash and fewer shares. The company has less cash and more of its own shares.

Bond Buy-Backs

With a bond buy-back, a government buys back bonds it previously issued. Bonds are like loans people give to the government. With a buy-back, the government pays money to retire some of those loans early.

Governments do bond buy-backs for a few reasons:

To lower interest costs if rates have fallen since the bond was issued To remove bonds from circulation and issue new bonds at different rates or terms To inject money into the economy and lower interest rates in general

Here’s how a bond buy-back by a government works:

1. The government announces a plan to buy back a certain amount of a certain bond.
2. The government buys those bonds from banks, funds, or investors who currently own them.
3. The government pays the current market price for the bonds, which could be more or less than the original price.
4. The repurchased bonds are retired. The government has less outstanding debt now.
5. By increasing demand for bonds, the buy-back raises bond prices. Since bond prices and interest rates move in opposite directions, this lowers rates across the economy a bit.
6. Sometimes the government then issues new bonds to replace the bought-back ones. The new bonds have different terms and rates based on current markets.

Pros and Cons of Buy-Backs

Buy-backs sound great but they have downsides too.

Pros

For share buy-backs:

• Boosts stock price
• Increases EPS
• Provides cash to shareholders
• More flexible than dividends

For bond buy-backs:

• Lowers government borrowing costs
• Stimulates the economy by lowering rates
• Allows government to update borrowing terms

Cons

For share buy-backs:

• Suggests company has no better uses for cash
• Could boost EPS without actual business improvement
• Uses cash that could go to investment, R&D, etc.
• Mainly benefits short-term traders, not long-term owners

For bond buy-backs:

• Uses government money that could fund services
• Asset price inflation could create bubbles
• May just kick the can down the road on debt
• Could weaken currency if done to excess

Recent Examples of Buy-Backs

In recent years, buy-backs have happened a lot as interest rates have been low.

Apple’s Huge Buy-Backs

Apple is famous for its massive share buy-back programs. From 2012-2019, Apple bought back over $300 billion of its own stock. More than any company ever before.

Apple generates huge piles of cash and prefers using it for buy-backs to boost EPS rather than paying taxable dividends. Apple’s EPS growth and stock price have looked great. But some criticize Apple for not using more cash to invent the next big thing.

The Fed’s Bond Buy-Backs

In response to the 2008 crisis and 2020 pandemic, the Federal Reserve has done huge bond buy-back programs called “Quantitative Easing.” The Fed creates new dollars to buy Treasury bonds and other government debt. This injects cash into the banking system, lowers interest rates, and aims to stimulate borrowing and economic activity.

From 2008-2014, the Fed bought over $3.5 trillion in bonds. Its balance sheet went from under $1 trillion to $4.5 trillion. This unprecedented monetary stimulus likely prevented much worse economic damage. But critics worry about asset bubbles and long-term inflation.