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Stock Buybacks: How Repurchases Work and What They Change

A buyback is a company purchasing its own shares. Methods, the effect on earnings per share, the SEC Rule 10b-18 safe harbor and the 1% US excise tax.

By Published 5 min read

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Key takeaways

  • In a buyback, a company pays cash to repurchase some of its own shares, reducing the number outstanding; it retires them or holds them as treasury stock.
  • Open-market repurchases are by far the most common method; tender offers and Dutch auctions are alternatives.
  • Fewer shares means higher earnings per share even if total profit is unchanged, so EPS growth can come partly from buybacks.
  • SEC Rule 10b-18 offers a voluntary safe harbor from manipulation claims if purchases meet conditions on manner, timing, price and volume.
  • Since 2023, US-listed domestic corporations generally owe a 1% excise tax on the fair market value of stock repurchased, net of stock issued.

When a company announces a "share repurchase programme" worth billions, it is planning to spend cash buying its own stock. Wikipedia's overview describes a buyback as distributing cash to existing shareholders in exchange for a fraction of the company's outstanding equity: cash goes out, and the number of shares outstanding goes down. The company either retires the shares or holds them as treasury stock, which can be reissued later.

Buybacks matter to ordinary investors because they change the arithmetic of every per-share number.

How companies buy back shares

Wikipedia lists six main methods under US corporate law. The three most visible:

Method How it works
Open market The company announces a programme and buys shares on the exchange from time to time, keeping the option of deciding whether, when and how much to buy. Wikipedia puts it at almost 95% of US repurchases.
Fixed-price tender offer The company offers to buy a stated number of shares at a set price, often a premium to the market, for a set period. Shareholders choose whether to tender.
Dutch auction Introduced in 1981, it names a price range; shareholders tender at prices within it, and the company sets a single purchase price from the responses.

Open-market programmes can run for months or years, and an announced programme is permission to buy, not a commitment to buy every share.

What a buyback does to earnings per share

Earnings per share is net income divided by shares outstanding, so cutting the share count raises it even when profit does not change. A simplified example:

Before After buying back 10%
Net income $100 million $100 million
Shares outstanding 50 million 45 million
Earnings per share $2.00 about $2.22

EPS rises by about 11% with no change in the business. Real results are less tidy, because the cash spent no longer earns interest, or was borrowed, which can reduce net income. The lesson for reading results: when EPS grows faster than net income, a falling share count may be part of the reason. Earnings per share explained and how to read an earnings report show where to find the share count.

Your ownership changes too. Holding 1,000 shares, you own 0.0020% of a company with 50 million shares; after the buyback, 0.0022% of one with 45 million.

Buybacks versus dividends

Wikipedia notes that repurchases are an alternative to dividends as a way of returning cash. The differences:

  • A dividend pays every shareholder in proportion to their holding; see how dividends work.
  • A buyback pays only shareholders who sell, while those who keep their shares own a larger slice.
  • Flexibility. Wikipedia notes that markets view a dividend cut more negatively than a cut in buybacks, so repurchases are seen as more flexible and may be used to distribute cash flows that might not last.

Companies may also buy back shares to signal that they think the stock is undervalued, especially through a tender offer at a premium. Wikipedia notes that scholars also caution that the flexibility of repurchases means the signal can sometimes be misleading.

The criticisms

Wikipedia summarises several lines of criticism from academic research and commentators:

  • Executive pay. Part of executives' rewards may be tied to share-price or EPS targets, which buybacks can lift; research cited there finds executives are more likely to sell their own shares shortly after a repurchase programme is announced.
  • False signals. Because authorising an open-market programme does not require any purchases, an announcement can mislead investors.
  • Light regulation. Rule 10b-18, described below, has been criticised for leaving repurchases "virtually unregulated".
  • Investment. Some argue heavy buyback spending can crowd out capital spending such as research and development.

The SEC safe harbor in Rule 10b-18

A company buying its own stock could be accused of manipulating the price. SEC Rule 10b-18 provides a voluntary safe harbor from liability for manipulation, based on the manner, timing, price and volume of repurchases. To be covered on a given day, purchases must meet all four conditions; failing any one removes all of that day's purchases from the safe harbor. In outline:

  1. Manner: purchases go through only one broker or dealer on any single day.
  2. Timing: not the opening purchase of the day, and not in the last 10 minutes before the close for actively traded stocks (those with average daily trading value of $1 million or more and a public float of $150 million or more), or the last 30 minutes for others.
  3. Price: no higher than the highest independent bid or the last independent transaction price, whichever is higher.
  4. Volume: no more than 25% of the stock's average daily trading volume over the previous four calendar weeks, with a once-a-week block purchase exception.

The 1% excise tax

Since 2023, US companies have paid tax on buybacks. Section 4501 of the Internal Revenue Code, added by the Inflation Reduction Act in August 2022, imposes a tax equal to 1% of the fair market value of stock a covered corporation repurchases during the year. A covered corporation is a domestic corporation whose stock trades on an established securities market. The amount is reduced by the fair market value of stock the company issues in the year, including stock issued to employees, and the tax does not apply if repurchases total $1 million or less. It applies to repurchases after 31 December 2022.

For a company that buys back $1 billion of stock and issues $200 million to employees in the same year, the taxable base would be $800 million and the tax about $8 million, before any other exceptions in the statute.

What to look for as an investor

A buyback is neither good nor bad in itself. Useful questions: Is the company paying a sensible price, judged against measures such as the P/E ratio? Is it borrowing to buy? Does the falling share count mostly offset shares issued to employees? Is EPS growth coming from the business or from the share count? Market capitalization explains how share count and price combine into company value.

Learn to Trade Stocks Beginner, one of our education apps, uses virtual money for practice trades. The investing basics hub lists related guides.

Good to know

Frequently asked questions

Why do companies buy back their own stock?
Wikipedia's overview gives two common reasons: to return cash to shareholders as an alternative to dividends, and to signal or take advantage of a belief that the shares are undervalued. Critics point to misuses too, such as lifting per-share measures that executive pay is tied to.
Do buybacks raise the share price?
Not automatically. They reduce the share count and raise earnings per share, but the share price still depends on the business and on what investors expect. An announced open-market programme does not even require the company to buy any shares.
What is Rule 10b-18?
An SEC rule giving companies a voluntary safe harbor from liability for manipulation, based on the manner, timing, price and volume of their repurchases. To qualify on a given day, purchases must meet all four conditions, such as using one broker per day and staying within 25% of average daily trading volume.
Is there a tax on stock buybacks?
Yes, for US companies. Section 4501 of the Internal Revenue Code imposes a 1% excise tax on the fair market value of stock repurchased by a covered corporation, reduced by stock it issues during the year. It applies to repurchases after 31 December 2022 and not if repurchases in a year total $1 million or less.

Sources

  1. Share repurchase (opens in a new tab)Wikipedia — accessed
  2. 17 CFR § 240.10b-18 – Purchases of certain equity securities by the issuer and others (opens in a new tab)Legal Information Institute, Cornell Law School — accessed
  3. 26 U.S. Code § 4501 – Repurchase of corporate stock (opens in a new tab)Legal Information Institute, Cornell Law School — accessed

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