How Do Stock Buybacks Actually Work?

In this video, Mac Greer welcomes Ron Gross andMatt Argersinger toMarket Fooleryas theydelve into some of the lesser known details behind corporate share repurchases, including rules regarding material non-public information and when stock buybacks are actually the best use of capital.

A full transcript follows the video.

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This podcast was recorded on March 8, 2017.

Mac Greer:We're going to begin with a question about stock buybacks from Tom Smith from Antioch, California. Tom also identifies himself as listener No. 13, and he's aStock AdvisorandRule Your Retirementmember.

Ron Gross:A baker's dozen!

Greer:A baker's dozen. And he's a member, so bump up your game. Tom's question: How are stock buybacks actually done? For example, didHome Depotjust put$15 billion in theirSchwabaccount and then put in a limit order? It seems like they have to be careful not to make huge purchases that would shoot their stock price up, too. I'm just curious as to the mechanics of the repurchase process. Ron Gross?

Gross:Nothing says good podcasts like the mechanics of stock buybacks, but I will refer everyone to SEC rule 10b-18. Of course, I'm sure most of us are familiar with it.

Greer:Wow. This is where we lower expectations.

Matt Argersinger:This is getting interesting.

Gross:No, but the bottom line is, yes, you do certainly need a broker. It's not your Schwab account, it's an actual human being who can work and order for you and make trades for you. There's many, many rules associated with stock buybacks, a big one being that you can't be in possession of material nonpublic information, so insider information, which is actually kind of hard, because everything is inside when you work for a company. But it can't be really material, something that you know will affect the stock either way. You only can use one broker in any given day. You can't have many brokers out there putting out different bids for a stock for you,for example. You can't buy more than 25% of the daily volume. You can't be the first trade of the day, you can't trade in the last 30 minutes of the day. Lots and lots of different rules you must follow to keep everything on the up-and-up. Once you get the hang of it, it's not too hard to stay compliant.

Argersinger:I'd say it's fair to say that Home Depot is not opening a discount brokerage account at Charles Schwab. They obviously have a specialist, probably someone at a major brokerage or investment bank that's able to buy in bulk, I would imagine. That's generally how it works.

Greer:Related question here: When are stock buybacks a bullish indicator, and when should investors beware?

Gross:The easiest thing to say is, it's a great use of capital when the stock is undervalued. But how do you judge that? That's the trick. Companies, history has shown, will often buy their stock back at the wrong time, when the stocks aresomeone overvalued, and that is a terrible use of capital, and it destroys shareholder value. So, you have to be careful. Another reason I hate to see stock buybacks is when the company is trying to offset the dilution caused by issuing options to its employees. I understand why it's done, but you don't want to see that, typically, as a good use of capital. So, if they have a lot of cash, they don't have growth opportunities for all of it, they see their stock as being a great growth opportunity at a good price, then go for it, buy all the stock you can back.

Mac Greer has no position in any stocks mentioned. Matthew Argersinger has no position in any stocks mentioned. Ron Gross has no position in any stocks mentioned. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.