Types

• The two main ways companies go about buying back their stock are through a tender offer to shareholders or by purchasing their own shares on the open market. In a tender offer buyback, the company offers its current shareholders the opportunity to sell back their shares. In the offer, the company stipulates how many shares it wants to buy back and the price range in which it is willing to pay for the shares. In an open market buyback, the company simply purchases its own shares on the open market.
  
  

Reduction in Assets and Equity

• When a company buys back shares either through a tender offer or the open market, the company’s cash account decreases when it pays the shareholders or when it purchases shares. A reduction in cash means a reduction in overall assets since cash is an asset account. Additionally, the buyback reduces the number of shares outstanding, which means a reduction in shareholder’s equity. However, these reductions in assets and equity actually increase the company’s return on assets (ROA) and return on equity (ROE).
  
  

ROA Increase

• To calculate ROA, you divide net income by total assets. In a stock buyback, the net income does not change, but the assets decrease. For example, a company has total assets of $5 million and net income of $1 million. Its ROA is then $1 million divided by $5 million, which equals 20 percent. The company completes a share repurchase that reduces its assets to $4 million. The new ROA is $1 million divided by $4 million, or 25 percent. The reduction in assets caused by the buyback increased the ROA by 5 percentage points.
  
  

ROE Increase

• To calculate ROE, you divide net income by shareholder’s equity. Again, the stock repurchase does not change net income but decreases shareholder’s equity because after the buyback, there are fewer shares outstanding. If a company has $10 million in net income before the buyback and stockholder’s equity of $100 million, then the ROE is $10 million divided by $100 million, which is 10 percent. The buyback reduces stockholder’s equity in half to $50 million. After the buyback, the ROE is $10 million divided by $50 million, or 20 percent.