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What are treasury stocks and why do companies engage in their purchase?

What are treasury stocks and why do companies engage in their purchase?

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Treasury stock is the outstanding stock that is bought back or repurchased from stockholders by the company which has issued these shares in the first place. These shares are issued but not outstanding and are excluded in the calculation of dividends or earnings per share. A treasury stock or reacquired stock is the stock which is also bought back by the issuing company thereby decreasing the amount of outstanding stock in the open market. In other words the Treasury stock is that part or portion of shares that a company keeps in its own treasury. They share have come either from a part of the float and stock outstanding before being reacquired by the company or may have emanated from the shares that have never been issued to the public.

The various why companies engage in purchase of its shares is as follows:

  1. The reasons why a company would engage in reacquisition of its own shares are for the following purposes like consolidation , improving its key financial ratios.
  2. Companies raise fund for expansion purpose by issuing equity shares , and when there is no potential growth opportunities that they can think of or visualize then, holding on to all that unused equity shares would means sharing ownership for no good reason. Shareholders demand returns on their investments in the form of dividends which is a cost of equity – so the business ends up paying for the funds that it is actually not using. Buying back some or all of the outstanding shares is a simple approach to pay off investors and also reduce the overall cost of capital .
  3. In the event of a recession, share reacquistion can be decreased more easily than dividends, with a lesser negative impact on the stock price.
  4. Companies engage in buybacks because many a times they seriously feel that their shares are undervalued. Undervaluation happens due to various reasons like the inability of the company to focus on areas other than the short term performance of the company , or a general bearish attitude etc. So when the stock is undervalued, the issuing company can repurchase some of its shares at this reduced price and then re-issue them when the market gets corrected and therefore having an effect of increasing its equity capital without issuing any additional shares.
  5. Companies resort to buybacks more frequently as it is a way to increase or boost executive compensation. Shareholder dividends are paid out of a company's net profit. If there are lesser number of shareholders, then the resources are divided into fewer pieces. Therefore Repurchasing the company’s outstanding shares enables the companies to increase executive compensation by making the company look more profitable.
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