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 repurchase can serve multiple purposes, such as boosting the stock price, improving financial ratios, or providing shares for employee compensation plans. Treasury stock is not considered when calculating earnings per share and does not have voting rights, making it a unique category of stock that impacts the company's overall equity.

5 Must Know Facts For Your Next Test

1. Treasury stock does not pay dividends since it is not considered an outstanding share, meaning companies can save money when they repurchase their own stock.
2. When a company holds treasury stock, it can use these shares for various strategic purposes, like fulfilling employee stock options or supporting mergers and acquisitions.
3. The repurchase of shares can signal to the market that a company believes its stock is undervalued, potentially boosting investor confidence and share prices.
4. Treasury stock can affect financial ratios like return on equity (ROE) since it reduces the total equity reported on the balance sheet.
5. Companies may decide to reissue treasury stock later, either by selling it back into the market or using it for acquisitions or employee benefits.

Review Questions

• How does treasury stock impact a company's financial ratios, particularly return on equity?
  • Treasury stock impacts a company's financial ratios by reducing the total equity reported on the balance sheet. Since return on equity (ROE) is calculated by dividing net income by shareholder's equity, holding treasury stock can artificially inflate ROE. This is because with less equity on the balance sheet due to treasury shares being deducted from outstanding shares, the same level of net income leads to a higher ROE percentage.
• Discuss the strategic reasons why a company might choose to engage in stock repurchases and hold treasury stock.
  • A company might choose to engage in stock repurchases for several strategic reasons. One key reason is to signal to investors that management believes the stock is undervalued, which can lead to increased investor confidence and potentially higher share prices. Additionally, holding treasury stock allows companies to manage their capital structure more effectively by reducing outstanding shares, thereby increasing earnings per share. It also provides flexibility for future corporate actions like issuing stock options for employees or funding acquisitions.
• Evaluate how treasury stock can influence a company's long-term strategy and investor perception.
  • Treasury stock can significantly influence a company's long-term strategy by providing management with flexibility in capital allocation. By repurchasing shares, companies can return excess cash to shareholders while also controlling the amount of outstanding shares. This action often boosts investor perception as it indicates confidence in the company's future performance. However, if not managed properly, excessive repurchases could lead to concerns over management's commitment to growth investments or indicate potential financial distress. Thus, it's crucial for companies to balance their use of treasury stock with their overall strategic goals.

Related terms

Stock Repurchase:

A stock repurchase occurs when a company buys back its own shares from the marketplace, which can help reduce the number of shares outstanding and potentially increase the value of remaining shares.

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

Dividends: Dividends are payments made by a corporation to its shareholders, typically in the form of cash or additional shares, reflecting the company's profits and providing a return on investment.