How Stock Buybacks Work and Why They Matter

Corporate stock buybacks are an important driver of equity market returns, but their real impact for shareholders is often misunderstood. When companies repurchase their own stock, they return capital to shareholders by lowering their outstanding share count and boosting earnings per share (EPS).

However, buybacks can also be controversial. Some investors believe they can affect companies' health over the long term by diverting cash away from investments in areas like research and development and employee compensation.

It's critical for investors to understand why companies use stock buybacks, as well as the potential benefits and risks of doing so. This information is key for evaluating whether a stock buyback program aligns with shareholder interests or if it's a short-sighted, risky move.

A stock buyback occurs when a company repurchases its own outstanding shares, lowering the number of available shares on the market. This effectively makes current owners' shares more valuable because their shares now represent a larger piece of the company. Buybacks also boost EPS because the same amount of earnings is distributed across fewer shares, and they can impact valuation metrics like the price-to-earnings (P/E) ratio, making a stock seem more reasonably valued despite unchanged earnings.

One way to measure the impact of buybacks is through the buyback yield, which shows how much a company has spent buying its own shares relative to its market value. It functions much like a dividend yield but reflects capital returned to shareholders through repurchases instead of dividend payouts. For example, a company with a $100 billion market capitalization that repurchased $5 billion of its stock over the past year has a buyback yield of 5%.

Some common motivations for stock buybacks are to return capital to shareholders, lift EPS, and make valuation metrics more appealing to potential investors. However, companies have other motivations for repurchasing shares:

• Signal confidence. Buybacks can demonstrate management's confidence in the company's long-term prospects, sending an optimistic message to the market and employees.
• Offset dilution. Employee stock compensation programs or share offerings can dilute current shareholders, reducing their ownership stake. Buying back stock can offset or eliminate this dilution's impact.
• Tax efficiency. Buying back shares can reduce the tax burden on investors relative to dividend payments, which incur capital gains.
• Mature industries. Repurchasing shares can sometimes be a sensible use of capital in mature, slow-growing industries where organic growth opportunities are often limited.
• Prevent hostile takeovers. Companies sometimes attempt to prevent hostile companies or activist investors from taking control of their firm by buying back stock to reduce the number of available shares on the market.

Companies may also opt for buybacks during periods of market weakness if they believe their stock is undervalued and therefore an attractive investment relative to other opportunities. And buybacks can become more appealing when interest rates are low because excess cash generates minimal returns and borrowing money to repurchase shares is cheaper than in a high-interest-rate environment.

Combined, these factors help explain changing trends in buyback activity. The chart below shows how the buyback yield for S&P 500® companies declined between the second quarter of 2022 and mid-2025 as companies spent less money repurchasing stock relative to their market caps.

This occurred partly because buybacks were more attractive in 2022 when markets were down and interest rates were relatively low compared to 2025, when markets routinely hit record highs and rates remained elevated.

Stock buybacks have always played a role in U.S. markets, but their legality was not always as clear as it is today. Under section 9(a)(2) of the Securities Exchange Act of 1934, the Securities and Exchange Commission (SEC) prohibited market manipulation, including trading activity that artificially inflated stock prices. This put stock buybacks in a regulatory gray area for decades.

Companies could—and often did—repurchase their own shares, but buybacks that were particularly aggressive or executed at sensitive times (like before earnings reports) often led to SEC scrutiny or enforcement actions.

Then, in 1982, the SEC adopted Rule 10b-18. This created a "safe harbor" that prevents companies from being held liable for market manipulation for stock buybacks. Companies must, however, abide by certain restrictions regarding the disclosure, timing, manner, volume, and pricing of buybacks.

Repurchasing stock is now a common way for companies to return capital to shareholders and manage their share counts. In 2024 alone, S&P 500 companies bought back $942.5 billion worth of their own stock, according to S&P Global.

When a company decides to buy back its own stock, it must outline how the buybacks will occur in a repurchase agreement. These agreements typically need to be approved by a company's board of directors, who authorize a maximum dollar amount or number of shares the firm may purchase.

Different share buyback methods can affect the timing, cost, and transparency of repurchases. Understanding these mechanics can help investors better interpret the potential impact of stock buybacks.

Companies can repurchase shares using four methods:

• Open-market purchase. Most share repurchases happen on the open market when a company simply buys back its shares at the current market price.
• Tender offer. Companies undergoing corporate restructuring or attempting to prevent or perform a takeover often offer to buy a set number of shares at a specific price from shareholders.
• Dutch auction tender offer. Companies can auction off their stock to shareholders by setting a price range and total dollar amount of shares they're looking to repurchase. The goal is to buy back shares at the lowest possible price within the set price range. This usually occurs over just 20 days to repurchase shares quickly, but companies also use these auctions during initial public offerings (IPOs), mergers, and acquisitions.
• Privately negotiated repurchase. Sometimes companies privately approach large shareholders to buy back their stock. This involves a formal offer to buy a specific number of shares at a set price and is often done to remove an activist investor or during corporate restructuring. 

Buybacks can effectively return capital to shareholders when they're done under the right circumstances. When a company has stable cash flow, believes its stock is undervalued, or wants to offset dilution from employee stock compensation, buybacks often create long-term shareholder value without straining the business.

However, investors shouldn't always celebrate buybacks. When companies prioritize buybacks over essential investments—such as research and development, marketing, or hiring—they can make their businesses less competitive over the long term. Repurchasing shares at elevated prices can further negatively impact shareholder value. Also, relying on debt to finance buybacks can strain cash flows and make companies more vulnerable during economic downturns.

Ultimately, buybacks can be a useful capital allocation tool, but they aren't always a net positive for companies. Investors should remember that rising EPS due to buybacks doesn't necessarily mean a company's underlying business has improved. And buybacks don't guarantee higher stock prices or management confidence. Looking beyond headline numbers when assessing the potential impact of buybacks is critical.

It can be difficult to evaluate whether a stock buyback program is likely to add to or detract from shareholder value. Consider the following tips:

• Review the balance sheet and cash flow statement. Buybacks are usually more sustainable when supported by a healthy balance sheet with strong cash flows. They're typically riskier when executed using debt. Investors should analyze a company's financials after they initiate a buyback program.
• Monitor long-term outstanding share counts. If a company continually repurchases stock but its outstanding share count doesn't decline, it can signal that these buybacks are mostly used to offset employee stock compensation. Companies with declining share counts, on the other hand, often return capital to shareholders more efficiently.
• Pay attention to stock buyback timing. Share repurchases tend to be more effective when a company's valuation is low or reasonable, rather than when it's elevated. Generally, companies should be able to find more effective uses for their cash on hand when their share price is high.
• Compare share repurchase agreements to actual buybacks. Companies can announce share repurchase agreements but lack follow-through due to financial strain, economic downturns, or other issues. It's important to track the number of shares actually repurchased, rather than stock buyback announcements.
• Look for aligned incentives. Sometimes management teams use buybacks to temporarily inflate EPS or total shareholder return metrics so they can meet performance-based compensation targets instead of focusing on long-term shareholder value. Consider reviewing executive compensation plans in SEC filings after a stock buyback plan announcement.

Investors often misinterpret buybacks, and the general public sometimes maligns them.

The former group typically sees buybacks as a positive development—a sign the company believes in its business, sees its stock as undervalued, or seeks to return capital to shareholders efficiently. On the other hand, the public may view buybacks with skepticism, fearing they're simply a way for corporate executives to enrich themselves.

In reality, buybacks are just a capital allocation tool that can either be used effectively or potentially misused. Recognizing the difference is key for investors. Buyback programs can be beneficial for shareholders if they're supported by healthy cash flows and executed as part of a broader strategy when a company trades at a reasonable valuation. But when struggling companies buy back stock at elevated prices using debt, it can be a recipe for disaster.

That's why it's important to understand why a company is repurchasing shares, how the buybacks are being funded, and whether management's incentives align with those of shareholders.