Article Reference:

http://online.wsj.com/news/articles/SB10001424052702304607104579213403150284332

Companies buyback their outstanding shares for a number of reasons. Some of these reasons are:

1. To distribute earnings in a tax-effecient way. Paying dividends creates a tax liability on shareholders. Buying back shares, on the other hand, is more effective in terms of taxes paid by investors.

2. To compensate for stock options and bonuses. When the company issues stock options, the number of outstanding shares in the market increases. To offset this effect and contain dilution of ownership, companies may choose to buyback currently outstanding shares and use these to issue stock options.

3. The company feels the stocks are undervalued. So they buy it back at the undervalued price.

4. Boost key financial measures such as Return on Equity and Earnings per Share. When shares are repurchased, the number of shares outstanding decreases but the earnings of the company remain unchanged. This boosts key ratios.

5. Push up the stock price. When shares are repurchased, a scarcity is created in the market which automatically pushes up prices.

6. Lastly, to signal to the market that the company is optimistic about its growth prospects. Share repurchases send a message to the investors that the company is performing well and the management, which knows the most about the company, is confident  about its future potential, which is why they are buying back shares. This serves to mollify investors and reduce investor pressure on the management.

Novartis, which has come under a lot of pressure from its investors of late, is using the share buyback program to pacify them and renew their confidence in the company. Because their current prices have not progressed in alignment with industry prices, they are trying to project to the market that they think that the company is undervalued and its potential is much higher than what current prices reflect.

As noted by the Citigroup analyst, the buyback also improves the performance of the company on paper (“materially elevated”) because key measures like Price per Share will automatically improve upon buyback even though the actual performance of the company remains the same.