A share buyback is a concept where a company buys back shares from the public using its own cash. Think of it as something opposite to an Initial Public Offering (IPO) where the public buys shares from the company.
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There is no single reason why companies consider a buyback. Excess money in balance sheets and undervaluation of share price are a couple of common reasons why companies go for a share buyback. When the number of shares in the market reduces, there is an improvement in Earnings per Share (EPS) for the remaining shareholders.
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As an investor, the important question is: Should you sell your shares or not? This is not an easy decision to make. Buybacks can be a fantastic opportunity to sell your shares at a premium and get good returns but on the other hand, you could stand to lose out on the future growth of the company.
One of the most important factors in a buyback is the offer price. Is the buyback offer price significantly higher than the current market price of the stock? If the answer is no, you may not benefit a great deal from the buyback. Also remember that if you have held the shares for less than a year, you would also have to pay a short term capital gains tax of 15%.
Surplus cash on a company’s balance sheet does not look very good. It indicates that the company is inefficient in utilising its assets. And if a company does not have many viable projects for the near future, it may consider utilising the cash to buy back shares from shareholders. If a company does not have future growth potential, it may be better to participate in the buyback and sell your shares.
If the company has solid fundamentals and you are looking for long term growth, it may be best to hold onto the stock and ignore the buyback offers. In this case, future potential growth may be better than the returns you earn in the short term.
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