On occasion, companies announce a plan to buy back stock. There are several reasons that explain why this can be good for shareholders as well as for the company.

A company may want to buy back stock to use up extra cash that the company has on its books. This is a good idea for the company if the money is not needed for expansion, etc. and if the stock is seen as undervalued by the company. The company can buy stock at a cheaper price, hold it for a period of time, then issue the stock back onto the market when the price has increased. This would also reduce the money to be paid out in dividends, since there would be less shares outstanding. If the company officers see the stock as a bargain, investors may consider the purchase a bargain also and buy into it.

Some companies buy back stock to clean up dilution. Dilution may occur after stock options are exercised or after restricted shares are allowed to be sold. This buy back would decrease the number of shares on the market, making each investor own a larger percentage of the company. This process boosts the earnings per share, which may lead to an increase in share price.

In any case, investors should question why the company is spending money on stock instead of on the business. Due diligence should confirm that the company has growth opportunities and new products to research. An investor should keep in mind that a buy back announcement usually boosts the share price and is generally a good thing for investors, as long as the company performs after the buy back.

For additional information on company buybacks, visit Zack's Investment Research.