Nvidia on Monday added $150 billion to its stock repurchase program, which the company says is the largest increase in its history. The company currently plans to buy back shares worth $235 billion by January 2028.
But what does it actually mean for investors when a company buys back its own stock?
Companies typically buy back their own stock when they have excess cash, and often buy their own stock on the open market. Nvidia CEO Jensen Huang told CNBC’s “Squawk Box” that the company expects to generate “a lot of cash over the next few years” and would like to return some of it to shareholders.
In fact, share buybacks, like dividends, are seen as a way for companies to give back to those who have invested in their stock. Unlike dividends, which come directly to shareholders in the form of cash, share buybacks reduce the number of shares in circulation, allowing existing shareholders to retain a larger portion of the company.
Nvidia’s announcement comes as stock buybacks remain near record levels. However, it is not always easy to determine whether a stock buyback announcement is good news for investors.
“Stock buybacks are a receipt, not a reason to buy,” says Aaron Gaines, a certified financial planner with Gaines Capital Management in Georgia. Announcing a stock buyback only tells management that they intend to spend the company’s cash on stock; it does not tell them whether they got a good deal or not.
Stock buyback mechanism
Companies can use surplus funds in a variety of ways, including paying off debt, investing in new projects, and expanding their operations.
Fast-growing companies may be more likely to reinvest their funds to fuel further growth. More mature, cash-rich companies may instead choose to return some of that money to shareholders through dividends or share buybacks.
Dividends are cash payments based on the number of shares owned by shareholders. When a company announces a dividend, it also announces when eligible shareholders will receive their payment. Investors can receive the payment as cash income or use it to buy more shares. In taxable accounts, dividend payments are generally taxable income.
In the case of share buybacks, the promise to return cash to shareholders is less robust. The company authorizes the purchase of its own shares, but does not necessarily have to comply with the full amount.
When a company buys back its own shares, the number of shares in circulation decreases, and investors who continue to hold the shares end up owning a larger portion of the company.
Earnings per share (EPS) can also improve because a company’s earnings are distributed among fewer shares. This can make the stock look more attractive to investors, even if the company’s overall profits remain the same.
“Overall, essentially, earnings per share are increasing,” said Rob Leipert, a certified financial planner and vice president of financial planning at RB Capital Management.
Stock buybacks and dividends also differ in how much a company commits to returning cash in the future. When a company starts paying regular dividends, investors tend to expect the payments to continue and potentially increase over time. Leipert said investors may react negatively when a company cuts its dividend.
“The same cannot be said for share buybacks,” he says.
What should investors think about share buybacks?
Share buybacks can signal to investors that a company has cash to spend on its stock, and can indicate that management believes the stock is undervalued. However, that alone does not tell you whether a company is a good investment.
Instead, investors can focus on metrics such as free cash flow, earnings growth, company leadership and the stock’s performance relative to its peers, Leipert said.
When it comes to share buybacks themselves, a company’s balance sheet is important. A large amount of debt can be a red flag, Leipert said, especially if the company borrows money to buy back stock.
The price a company pays for its stock also matters. Buying back undervalued stocks can be a good use of cash, but overpaying can destroy value. One way investors value a stock is to compare its price-to-earnings ratio to the price-to-earnings ratio of similar companies, according to Fidelity.
“Stock buybacks are only good deals if companies are buying their stock at a fair price,” says Mark Stancato, a certified financial planner with VIP Wealth Advisors in Georgia.
There’s also the question of what else the company can do with that money. Leipert points to research and development and hiring as possible alternatives to stock buybacks.
Additionally, the amount a company spends on stock buybacks does not necessarily result in an equivalent reduction in the number of shares. Companies also issue new shares to compensate employees, which means some share buybacks simply offset dilution, Leipert said.
However, assessing a company’s financial health and reputation can be complex, which is where a financial advisor can help. However, even for investment professionals, share buybacks are just one factor to consider when determining whether a company is a good investment.
“I might mention it, but it’s not something I use to pick stocks or pick anything for a client’s portfolio,” Leipert says.
