Why Do Companies Buy Back Shares?

Over the past two weeks, we’ve explored why companies list on the stock market and how they decide whether to reinvest profits or pay dividends. But dividends aren’t the only way companies can return value to shareholders. Increasingly, companies are choosing to buy back their own shares.

Share buybacks often make headlines, yet they’re widely misunderstood. Some investors see them as a sign of confidence. Others think they’re simply a way to boost the share price. The truth is much simpler. When used responsibly, a buyback is just another way of returning capital to shareholders.

What is a share buyback?

A share buyback, also known as a share repurchase, is when a company uses its own cash to buy shares from existing shareholders.
These purchases can happen gradually on the open market, just like any other investor buying shares, or through a specific offer made directly to shareholders.

Once the shares have been bought back, they’re usually cancelled or classified as treasury shares. That reduces the total number of shares in issue, meaning every remaining shareholder automatically owns a slightly larger piece of the business without investing another cent.
Here’s a simple example.

Imagine a company has 100 shares in issue and you own 10 of them. You own 10% of the company. If the company buys back and cancels 10 shares, only 90 remain. You still own your 10 shares, but they now represent just over 11% of the business.

Nothing has changed in your investment, yet your ownership has increased.

This also explains why earnings per share often rise after a buyback. The company hasn’t necessarily made more money, but those profits are now spread across fewer shares.

South African investors have seen this strategy used extensively by Naspers and Prosus. Their buyback programmes have aimed to reduce the discount between their market value and the value of the assets they own, while simultaneously increasing each remaining shareholder’s ownership percentage.

Are buybacks better than dividends?

Not really. They’re simply different ways of achieving the same goal.

Both dividends and buybacks return excess capital to shareholders. The biggest difference is that buybacks give investors a choice.

When a company pays a dividend, every shareholder receives the dividend, whether they want it or not. If your goal is to stay fully invested, you now have to decide where to reinvest that dividend, potentially paying transaction costs along the way.

A buyback works differently.

Shareholders who want cash can sell some or all of their shares into the buyback. Those who believe the company still has attractive long-term prospects can simply do nothing. As other investors sell, the remaining shareholders automatically own a slightly larger percentage of the business.
That’s one of the biggest advantages of buybacks. They don’t force every investor down the same path. Each shareholder can decide whether they’d rather receive cash today or increase their ownership in the company for the future.

Neither approach is inherently better. A well-managed company should choose the method that creates the greatest long-term value for its shareholders.

Are buybacks always positive signs?

Like most things in investing, context is everything.

A buyback is generally viewed positively when a company has surplus cash, limited opportunities to reinvest at attractive returns, and believes its shares are undervalued.

However, buybacks can become controversial when they materially change who owns the company.

If some shareholders participate while others don’t, the ownership percentages of the remaining shareholders increase. In some cases, that can strengthen the control of a major shareholder or reduce the influence of minority investors. The buyback itself isn’t necessarily bad, but investors should understand how it changes the ownership structure.

Buybacks can also raise concerns if a company borrows heavily to fund them or uses them to distract investors from weakening business fundamentals. A rising earnings per share figure may look impressive, but if profits are falling and debt is climbing, the buyback may be masking bigger problems.

The concept is the same as it was with dividends. A buyback isn’t automatically good or bad. What matters is why management is doing it and whether it’s the best use of shareholders’ capital.

Every capital allocation decision tells a story. Whether a company reinvests its profits, pays a dividend, or buys back its own shares, each decision provides valuable insight into management’s confidence, priorities, and how they intend to create long-term shareholder value.

That brings our Business of Investing series to a close. Over the past few weeks, we’ve looked behind the share price to better understand how businesses operate and the decisions that shape their long-term success.