Some Buyback Cons

By repurchasing its stock, a company decreases the number of outstanding shares. A stock buyback thus enables a company to increase this metric without actually increasing its earnings or doing anything to support the idea that it is becoming financially stronger.

As an illustration, consider a company with yearly earnings of $10 million and 500,000 outstanding shares. This company's EPS, then, is $20. If it repurchases 100,000 of its outstanding shares, its EPS immediately increases to $25, even though its earnings have not budged. Investors who use EPS to gauge financial position may view this company as stronger than a similar firm with an EPS of $20 when in reality the use of the buyback tactic accounts for the $5 difference.

The key reasons buybacks are controversial:
1. The impact on earnings per share can give an artificial lift to the stock and mask financial problems that would be revealed by a closer look at the company’s ratios.
2. Companies will use buybacks as a way to allow executives to take advantage of stock option programs while not diluting EPS.
3. Buybacks can create a short-term bump in the stock price that some say allows insiders to profit while suckering other investors. This price increase may look good at first, but the positive effect is usually ephemeral, with equilibrium regaining when the market realizes that the company has done nothing to increase its actual value. Those who buy in after the bump can then lose money.