Treasury Stock

Definition

Treasury stock refers to shares that were once a part of the outstanding shares of a company but were later repurchased by the company itself. This action reduces the number of shares available in the market and can impact various financial metrics such as earnings per share (EPS) and shareholder equity. Companies may engage in treasury stock transactions for several reasons, including to increase shareholder value, to improve financial ratios, or to provide shares for employee compensation plans.

5 Must Know Facts For Your Next Test

1. Treasury stock does not have voting rights and does not pay dividends, as it is not considered an outstanding share.
2. Companies may use treasury stock for various purposes, such as funding employee stock option plans or facilitating mergers and acquisitions.
3. The repurchase of shares can signal to the market that a company's management believes the stock is undervalued, potentially boosting investor confidence.
4. When treasury stock is sold back into the market, it can increase the number of outstanding shares again, which may dilute earnings per share unless managed carefully.
5. Treasury stock is recorded on a company's balance sheet as a contra equity account, reducing total shareholders' equity.

Review Questions

• How does treasury stock affect a company's earnings per share (EPS) and overall financial health?
  • Treasury stock affects a company's EPS because when shares are repurchased, the total number of outstanding shares decreases. This can lead to an increase in EPS, making the company appear more profitable on a per-share basis. Additionally, reducing the number of outstanding shares can strengthen financial ratios such as return on equity (ROE), ultimately improving the overall perception of the company's financial health.
• Discuss the strategic reasons behind a company’s decision to buy back its own shares and hold them as treasury stock.
  • Companies may choose to buy back their own shares for several strategic reasons. One primary motive is to return value to shareholders by increasing EPS and potentially raising the stock price. Additionally, holding treasury stock allows companies to manage their capital structure more effectively and can be used for future employee compensation plans. It also provides flexibility for companies during mergers or acquisitions, enabling them to use treasury shares as currency in transactions.
• Evaluate how the treatment of treasury stock impacts both investors and management's decision-making in relation to corporate strategy.
  • The treatment of treasury stock has significant implications for both investors and management's decision-making. For investors, treasury stock can signal confidence from management regarding the company's future prospects, potentially influencing their investment decisions. For management, strategically managing treasury stock allows for effective capital allocation and can enhance financial metrics that are critical in guiding corporate strategy. Ultimately, how treasury stock is handled can reflect a company’s priorities—whether focusing on shareholder returns or reinvesting in growth opportunities.

Related terms

Share Repurchase: The process by which a company buys back its own shares from the marketplace, reducing the number of outstanding shares.

Outstanding Shares: The total number of shares currently held by all shareholders, including institutional investors and company insiders, excluding treasury stock.

Earnings Per Share (EPS):

A financial metric that indicates the profitability of a company on a per-share basis, calculated by dividing net income by the number of outstanding shares.