Penny Stock Buybacks - dummies

By Peter Leeds

A stock buyback takes place when a company buys back its shares on the open market and subsequently cancels, or eliminates, those shares. Any penny stock acquired in this fashion is thereby removed from the pool of available shares. Buybacks have a positive effect on the stock price.

In most cases, companies use buybacks (in addition to other methods) to increase their share price. Buybacks are typically implemented by companies that see themselves as undervalued and that also have plenty of cash in their coffers.

While buybacks aren’t common among penny stocks companies, which use all their funds for research and development or to drive and pay for growth, you may come across a share buyback from time to time.

Having fewer shares available benefits current shareholders. Here are some of the ways that a buy back can help the price of a stock:

  • Displays confidence: When a company buys back its own stock on the open market, it demonstrates that executives (who authorized the buyback) believe in their company’s future and feel that the shares are at undervalued prices.

  • Best use of funds: Often a buyback will come with a statement from management that this approach represents “the best use of funds.” In other words, the company has excess cash and doesn’t see as much value in any of the other channels for the funds.

    The fact that the company has money to spend demonstrates the success of its business, and using those funds to reduce the amount of outstanding shares should increase the value of the stock.

  • Reverses dilution: The fewer shares available, the greater portion of ownership in the company each of the remaining stock will have. Pay attention to what percentage of shares the penny stock intends to buy back because that should give you a direct understanding of how much the stock may rise in value.

    For example, if a company buys back 25 percent of its shares, theoretically the value of each remaining share should increase by 25 percent.

  • Increases demand: Buying back shares on the open market is a big plus for thinly traded penny stocks. The buyback creates demand for the stock, which can motivate other buyers to increase their bid prices. At the same time, the supply of shares being sold decreases because some sellers will have their stock purchased.

Buybacks are almost always positive for the shares, and in some cases they have significantly beneficial effects.