Treasury stock is a type of stock that is owned by the company that issued it. These shares are kept in the company's treasury and are not out in the open market. This type of stock has some advantages and disadvantages for both the company and for the investors in the company.
Improves Shareholder Value
One of the benefits of owning treasury stock is that the company can improve the shareholder value. The value of each share is based on the value of the company and how many shares are outstanding in the market. When a company buys back stock it does not necessarily change the value of the company, but it does change the number of outstanding shares. This pleases shareholders because it increases the value of each share of stock.
Shareholder Perception
When a company engages in a stock buyback to increase treasury stock, this also has the ability to improve the company's perception in the marketplace. When a company buys stock out of the market place, this is a signal to investors that the company has excess cash. A company that has excess cash sitting around is obviously doing well financially. This can signal other investors that they should invest in the company which will further drive up the price of the stock.
Tie Up Cash
One of the potential disadvantages of this maneuver is that it will tie up your company's cash. With treasury stock, you are basically holding onto shares of stock that are associated with your company. If you simply hold onto the shares, you cannot access the money that you have tied up in them. You would have to sell the shares of stock before you can gain access to the money. This can limit your cash flow and make things more difficult on you financially.
Manipulation
Some companies use treasury stock as a way to manipulate the value of their shares. One of the most common ways to gauge the value of a stock is the price-earnings ratio. With this method, you divide the price of the stock by the earnings per share. If you have fewer shares in the market place, this bumps up the value of the stock. Nothing fundamental has changed about the company, but it is still going up in value.