The term “buyback” carries the exact meaning of it, buyback of repurchase. The buyback is a particular mechanism by which a company buys back its own shares from the shareholders or market. Now, the question is why would a company buy back its own share with its money? This article is all about the concept of buying back shares. Here, you will get to know What is Buy Back of Shares? Why the mechanism is needed, and how shareholders can get benefited from the mechanism. So, let’s start from the very beginning.
What is Buy Back of Shares?
Let’s get into the main topic about what is the Buy Back of Shares from the Indian stock market perspective. Some of the investors get confused between the concepts of Buy Back of shares and dividends. Though they are almost alike in some perspectives, still there are differences between the two. Dividend payments generally contain an implicit promise while buybacks allow a company to reward shareholders without any tactic commitments.
In simple terms, Buyback is a special method that enables a company to purchase back its own shares from the shareholders. The buyback can be done through the open market purchase or through the tender route. In the Open market, the company buys back its own share from the secondary market. On the other side, under the tender offer, investors can tender shares during the buyback offer. Previously, most of the market preferred the open market route.
Now, the question is why does a company need such a mechanism? The answers lie below:
The Reason for the Buy Back of Shares
Generally, the buyback is applied by a company when the company has a significant cash reserve and the shares are undervalued in the market. After a proper analysis, we are able to list down the objectives or reasons for the buyback.
- To recover the undervalued stocks
- It helps to improve the EPS or Earnings Per Share.
- Other reasons include enhancing the long-term shareholders’ value and providing an additional exit route.
- To get an optimal capital structure.
- To prevent unwanted takeover bids.
- To return surplus cash to its shareholders.
Now, come to the most important point, why would an investor prefer a buyback?
Reasons Investors Prefer the Buy Back of Shares
Let me provide the reasons below:
Improve Shareholders Value
After buying back its share the company reduce the assets from the balance sheets and increase the return on assets. Hence, this cause reducing the number of shares, and as a result of it the EPS increase. Shareholders who are holding the shares, now have a higher percentage of ownership of the company’s shares.
A Boost in Share Prices
During the faltering economy, a company’s buyback program can bring a boost to the particular company’s share price. In order to reflect the value of the company, companies will repurchase first and then resell them once the price increase. This also results simplify the supply and demand.
The Tax Benefits
Traditionally, buybacks are taxed at a capital gains tax rate while dividends come under the income tax. When the repurchase program happens, instead of increasing dividend payments, shareholders have the opportunity to differ capital gains.
Excess Cash
When the announcement happens about buyback programming, it can be easily assumed that the company has additional cash on hand. So, investors do not need to worry about cash flow problems. Besides this, investors can guess that the company prefers to reimburse shareholders rather than reinvest in alternative assets.
The Limitation of Buy Backs
Besides advantages, there are several disadvantages also and investors should be aware of it. It can be a signal of the marketing topping out. Some companies apply buyback tricks to boost the share price artificially. Investors can find it by checking the earnings of the particular company. If a company’s earning is not increased but the company buyback values are increasing, it could be a false signal.
FAQ
Buyback of shares refers to a company buying its own outstanding shares from existing shareholders. For instance, Infosys recently announced that it would be buying back up to 11.3 crore equity shares at Rs 800 per share from the open market.
Generally yes, it can lead to an increase in dividend returns and long-term shareholder value due to the lower number of outstanding shares. Additionally, as demand increases due to fewer available stocks, this also tends to push up stock prices making it beneficial for shareholders to hold on to these stocks in the long run.
Companies usually announce a share buy-back program when they have no other meaningful option than returning cash profits/reserves of surplus earnings directly or indirectly by way of returning them through dividends either partly or fully; thereby increasing investor loyalty as well as restoring confidence In their brand story by raising their overall worth across different investing platforms.
Yes, you can sell your bought-back stock whenever you like depending upon your current investment goals and requirements in order to get better return profits periodically over time.
Conclusion
In conclusion, buy back of shares is a strategic measure that companies use to enhance their shareholder value and reduce overcapitalization. The process involves the company buying its own shares from the open market or issuing new stock at a price higher than existing prices. This can also indicate that the management believes that its stocks are trading below their fair value in terms of assets and will eventually appreciate in value. Overall, investing in buy-back stocks can be lucrative provided it has been implemented correctly by an experienced business team as it enhances investor’s confidence and provides additional sources of financing for companies requiring long-term capital investments.