What is Share Buyback?

  •  6 min read
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  • 28 Nov 2023
What is Share Buyback?

Key Highlights

  • It is commonly considered that an offer to buy back the shares of a company benefits its shareholders.
  • It helps to improve the value of the shareholdings, increases the return on capital and works to obtain a premium price.
  • Repurchases in India are conducted only by selling out the shares.
  • As the impact on valuation continues to be questioned, there is no denying that repurchasing stocks offers a tax-efficient way of returning cash to shareholders!

When companies decide to buy their shares from their existing shareholders through a tender offer or an open market, share or stock repurchase is the practice. Under this circumstance, the shares concerned are traded at higher than their respective market prices.

Companies can use the secondary market to repurchase shares if they use the open market process. However, individuals who choose the tender offer may still benefit if they submit or tender a portion of their shares during the allotted time. On the other hand, it might be viewed as an alternative way to reward current shareholders besides paying dividends on schedule.

On the other hand, company owners may have several reasons for repurchasing stocks. Individuals should ensure that they are aware of the reasons behind decisions and thus somewhat benefit from them.

A company may decide to buy back shares for several reasons. However, the most common reasons for this are highlighted in the list below.

1. This is a tax-efficient reward option

Stock repurchases are more tax-efficient for companies and their shareholders when compared to dividends. In other words, stock repurchases are subject only to DDT and the amount of their proceeds is reduced before they are distributed to shareholders who surrender shares. By contrast, dividends are subject to three different rates of taxation.

2. If there's excess cash, but there aren't enough projects to invest in

It is common practice for companies to issue shares to raise capital and expand their business, but this practice often does not prove helpful. Similarly, keeping excess funds in the bank is like a short cash flow that offers liquidity over an ideal requirement. As a result, companies with solid financing are more likely to make the best use of available resources through stock repurchases rather than building up cash reserves.

3. To consolidate the holding of the company

It is usually difficult for an entity to decide unitedly if its shares have increased over the reasonable limit. Moreover, it may cause a conflict of interest between the company and its shareholders with voting rights. The company's governing board members frequently use share repurchases to prevent or exacerbate such situations, and they also intend to strengthen their control through an increase in voting rights.

4. To signal that the stock is undervalued

A company may also indicate that it believes its shares have been undervalued when deciding to buy back those shares. It also helps to project a positive image of the company's prospects and current valuation, in addition to helping to address this situation. Other than that, stock repurchases can improve a company's overall value or reward its existing shareholders.

Declaring an upcoming share repurchase often indicates the company's prospects are profitable. In addition, it is assumed to have an impact on the overall share price of the company. For instance, investors often think repurchasing stock from shareholders is a likely signal of acquiring big companies, launching new and improved product lines, etc.

In any case, the stock buyback indicates that corporate shares will start to increase in value. In particular, such positive prospects can attract attention from investors wishing to take advantage of this favourable situation. However, in the event of a decrease in the value of the company's shares, some companies may resort to this method. They do so to avoid further deterioration of their capital.

Investors should consider several factors, such as the current trend of stock prices and recent earnings per share, which can be used to identify the true motive behind an equity repurchase. It will also give them an insight into the implications of such a decision.

The impacts of share buybacks are as follows.

1. The effect of EPS on earnings per share

By increasing the ratio significantly, the repurchasing of the company shares will have a direct impact on its earnings per share. This is mainly because net income remains the same while the total number of outstanding shares decreases after repurchasing.

2. The effects on the company's portfolio

The practice of recapitalising a company's stock is generally exercised by companies that believe in their prospects. Potential investors and existing shareholders are highly encouraged by such a reassuring display of confidence, which will help them gain considerable trust. It also helps to increase a company's reputation in its market and thereby allows for an increased share price. All of this is, ultimately, helping to improve a venture's portfolio significantly.

3. The effect on the financial statements

The money used to buy back company stock would show up under "financial activities" in the cash flow statement, statement of retained earnings, and the company's earnings report. The income statement of the corporation may also be impacted by share buybacks' effects on the other lines.

4. Effect of increasing the value of the shares

Business owners are more likely to increase their earnings significantly and at a much quicker rate than improvements in operational performance if they choose to buy back shares. Investors who seek profitable investment options tend to favour firms with stable EPS as a better source of revenues and higher potential for growth.

Additionally, businesses with the means to buy back their shares from investors have a strong market presence and pricing power. Therefore, the company's practice of returning shares is helpful in projecting a favourable image on the market and beneficial to prospective investors.

Conclusion

Therefore, current and prospective shareholders should consider the potential for a company to buy back its stock to plan their investments accordingly. However, they should be better acquainted with the impact on investors, existing shareholders and the company to understand the meaning and role of the share repurchase.

FAQs on Share Buyback

To restore profits to their investors, public corporations use share repurchases. It is good for shareholders when the company repurchases its stock, as it reduces the number of shares that remain in issue and increases their value.

No, the share buyback increases the share price.

The share buyback reduces the company's financial flow.

The company must pay tax as soon as the repurchase process has been completed and proceeds have been distributed to shareholders. To avoid double taxation, the Government of India grants a tax exemption to shareholders or investors regarding the income they receive from the repurchase.

Finally, share repurchases can be a very low-risk approach for companies that want to take advantage of additional cash.

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