How to Profit From Stock Splits and Buybacks (2024)

If stock splits and buybacks have been a bit of a mystery to you, you're not alone. While the number of companies initiating stock splits and buybacks ebbs and flows as market conditions change, most long-term investors have been affected by at least one of these events in the past. And if they haven't, it probably won't be long before they find themselves having to make an investment decision regarding one of these scenarios. In this article, we'll review buybacks, stock splits, and reverse stock splits, taking a close look at when each might be a good or bad deal for investors.

Key Takeaways

  • A stock buyback is when a publicly traded company repurchases its own stock and either cancels the shares or turns them into treasury shares.
  • Because a buyback reduces the number of shares available to trade in the market, the value of each existing share increases.
  • A company's management may initiate a buyback if they believe the stock is significantly undervalued and as a way to increase shareholder value.
  • While a stock split doesn't immediately increase shareholder value, investors can see it as a bullish sign for the company that could over time mean a rise in the stock price.

Stock Buybacks

A stock buyback takes place when a company uses its cash to repurchase stock from the market. A company cannot be a shareholder in itself so when it repurchases shares, those shares are either canceled or made into treasury shares. Either way, this lowers the number of shares in circulation, which increases the value of each share—at least temporarily.

In order to profit on a buyback, investors should review the company's motives for initiating the buyback. If the company's management did it because they felt their stock was significantly undervalued, this is seen as a way to increase shareholder value, which is a positive signal for existing shareholders. If they repurchased the shares because they want to make certain metrics look better when nothing material has changed, investors may see this as a negative causing the stock to sell-off.

Examples of a Stock Buyback

In September 2011, Berkshire Hathaway announced a share buyback where they actually disclosed the maximum amount they were willing to pay for the shares. Although the purchase price isn't normally disclosed, Berkshire increased the value of the stock for investors as the stock came within 0.1% of their maximum price on the day the repurchase was announced.

Between fiscal years 2017 and 2019, Microsoft (MSFT) bought back about 419 million shares for a total repurchase of $35.7 billion. In the quarter ending June 2019, the tech giant purchased $4.6 billion or about 3.8% of its own stock. Microsoft has a history of engaging in stock buybacks. In 2013 and again in 2016, the company's board of directors authorized $40 billion to repurchase stock.

How to Make Money on a Buyback

What's the best way to make money on a repurchase? Invest in companies with a strong balance sheet. This makes a share repurchase a positive action in the eyes of investors. As with any investing strategy, never invest in a company with the hopes that a certain event will take place. However, in the case of a growing and profitable company, a share buyback often happens as a result of strong fundamentals.

Critics of stock buybacks say the action emphasizes the short-term enrichment of shareholders at the expense of investing in the business itself, something that could negatively impact the company's growth over the long term.

Stock Splits

If you had a $10 bill and somebody offered to give you two $5 dollar bills in exchange, would you feel a little richer? A stock split doesn't add any value to a stock. Instead, it takes one share of a stock and splits it into two shares, reducing its value by half. Current shareholders will hold twice the shares at half the value for each, but the total value doesn't change. The ratio doesn't have to be 2 to 1, but that's one of the most common splits. The ratio is often dependent on the price. Higher priced stocks may split enough times to get the share price below $100.

Splits are often a bullish sign since valuations get so high that the stock may be out of reach for smaller investors trying to stay diversified. Investors who own a stock that splits may not make a lot of money immediately, but they shouldn't sell the stock since the split is likely a positive sign.

Reverse Splits

A reverse split works the opposite way of a split. Those two $5 bills would become one $10 bill. Reverse splits should be met with skepticism. When a stock's price gets so low that the company doesn't want it to look like a penny stock, they sometimes institute a reverse split. History has shown less than stellar results for companies that do this.

Remember that splits may be a reason to buy shares in a company and reverse splits may be a reason to sell shares.

What is a Stock Buy Back?

A stock buy back is when a corporation purchases its own shares, thereby reducing the number of shares available for purchase on the open market.

What is a Stock Split?

A stock split is when a company increases the number of its outstanding shares by dividing one share into two or more shares.

What is a Reverse Share Split?

A reverse share split is as its name suggests the opposite of a share split. The corporation combines two or more shares into one and effectively reduces the number of shares outstanding

The Bottom Line

Splits and buybacks may not pack the same punch as a company that gets bought out, but they do give the investor a metric to gauge the management's sentiment of their company. One thing is for sure: when these actions take place, it's time to reexamine the balance sheet. Look beyond what the company is saying is the reason for their actions and review how it might impact their financial statements going forward.

How to Profit From Stock Splits and Buybacks (2024)

FAQs

How to Profit From Stock Splits and Buybacks? ›

In order to profit on a buyback, investors should review the company's motives for initiating the buyback. If the company's management did it because they felt their stock was significantly undervalued, this is seen as a way to increase shareholder value, which is a positive signal for existing shareholders.

How do you profit from stock buybacks? ›

The share buyback price is pre-decided by the company. For every share tendered, investors benefit. In the open market option the company buys back shares from the open market over an extended period. In the tender offer, investors receive the benefit, as they can sell their shares at a higher price.

How do you take the benefit of a stock split? ›

Simultaneously, the share price is halved to maintain the same total market value. So, if a company's stock was trading at Rs 100 per share before a 2-for-1 split, after the split, the price per share would become Rs 50, and investors would have twice the number of shares they had before the split.

How do you profit from a reverse stock split? ›

If you own 50 shares of a company valued at $10 per share, your investment is worth $500. In a 1-for-5 reverse stock split, you would instead own 10 shares (divide the number of your shares by five) and the share price would increase to $50 per share (multiply the share price by five).

How do investors benefit from a stock split? ›

Companies often choose to split their stock to lower its trading price to a more comfortable range for most investors and to increase the liquidity of trading in its shares. Most investors are more comfortable purchasing, say, 100 shares of a $10 stock as opposed to 1 share of a $1,000 stock.

Who benefits from stock buybacks? ›

A buyback can benefit investors because they receive their capital back and are often paid a premium over the stock's market price. In addition, there is a boost in the share price for investors who still hold onto the stock; however, buybacks aren't necessarily always good for investors.

How do share buybacks return cash to shareholders? ›

A share buyback is when companies buy back their own shares from the market, cancel them and, ultimately, reduce share capital. With fewer shares in circulation, each shareholder gets both a larger stake in the company and a higher return on future dividends.

How does a stock split work for dummies? ›

In a stock split, a company divides its existing stock into multiple shares to boost liquidity. Companies may also do stock splits to make share prices more attractive. For shareholders, the total dollar value of their investment remains the same because the split doesn't add real value.

What is the formula for the stock split? ›

Calculating total shares after stock split

Shareholders who wish to estimate the total number of shares that they will own after a stock split can use the following formula: Total number of shares post stock split = number of shares held * number of new shares issued for each existing share.

Do you double your money when a stock splits? ›

While the number of shares owned changes after a stock split, the split itself does not change your investment value.

Is it better to buy before or after a stock split? ›

Does it matter to buy before or after a stock split? If you buy a stock before it splits, you'll pay more per share than what it'll cost after it splits. If you're looking to buy into a stock at a cheaper price, you may want to wait until after the stock split.

How many companies succeed after a reverse split? ›

Among the 1206 firms conducting a reverse stock split, we find that, within five years of the reverse split, 138 or about 11% are acquired by another company while 568 or about 47% enter bankruptcy or fail to meet listing standards.

Should I sell my stock before a reverse split? ›

Selling before a reverse stock split is a good idea, but selling after the reverse stock split is not. Since you can sell before and after a reverse stock split, selling during one is optional. The main advantage of selling before the reverse stock split is that you don't have to wait around for it to happen.

What is the primary purpose of a stock split? ›

By splitting the stock, the company essentially lowers the price per share, making it more affordable and attractive to potential investors. The number of outstanding shares will rise due to a stock split, while the par value and market price will drop.

What happens to your money after a stock split? ›

So, if you owned 5,000 shares of stock at a price of 10 cents per share worth a total of $500 before the reverse split, you would own 25 shares at a price of $20 each after the reverse split, maintaining that total value of $500. The amount of money you have invested doesn't change, just the number of shares you own.

What stocks are expected to split in 2024? ›

3 Potential Stock Splits to Add to Your 2024 Radar
  • Broadcom (AVGO) Source: Sasima / Shutterstock.com. Broadcom (NASDAQ:AVGO) is the most expensive stock on this list on a per-share basis. ...
  • Deckers Outdoor (DECK) Source: BalkansCat / Shutterstock. ...
  • Nvidia (NVDA) Source: Poetra.RH / Shutterstock.com.
Mar 20, 2024

Is share buyback profitable? ›

The market can also view that management has enough confidence in the company to reinvest in itself. Share buybacks are generally seen as less risky than investing in research and development for new technology or acquiring a competitor; it's a profitable action as long as the company continues to grow.

What happens if a company buys back all of its stock? ›

The correct answer is that a buyback of all shares is a liquidation. If there are zero shares, this can only mean the company no longer exists. Note that in normal (partial) buybacks, the company shrinks in value. The natural extreme of this is that the company disappears.

Is buyback good or bad for investors? ›

Buybacks benefit all shareholders to the extent that, when stock is repurchased, shareholders get market value plus a premium from the company. And if the stock price rises before the repurchase, those that sell their shares in the open market will see a tangible benefit.

Are share buybacks better than dividends? ›

The Bottom Line. Although many investors may think that buyback programs are benefiting them, intentions are often in favor of the company itself, and more specifically company insiders. Dividends on the other hand ensure direct payment to the shareholder, with much less risk than share buybacks.

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