A company should buy back its own stock when it believes the stock is what?

• A. Undervalued
• B. Overvalued
• C. At par value
• D. During a market crash only

Answer: (A)

A buyback is most sensible when management believes the stock is undervalued relative to the company’s intrinsic value. If the price is below what the business is actually worth, repurchasing shares using excess cash creates value for remaining shareholders: fewer shares outstanding raise earnings per share and can lift return on equity, while signaling confidence in the company’s prospects. It’s a way to invest in itself at a discount.

Buying back stock when the price is overvalued would destroy value, since paying a high price for shares reduces future value to shareholders. Par value is just a nominal accounting figure and doesn’t reflect market value, so it isn’t a driver for a buyback decision. And buybacks aren’t limited to market downturns; they’re used whenever the price is viewed as a good deal relative to intrinsic value and the firm has excess cash.