Are you wondering about how companies manage their finances and enhance the value of shareholders? One of the tools used by companies to enhance their market appeal is share buybacks. In this digital era, companies usually utilise their excess or surplus funds to buy back outstanding shares from respective shareholders in the market, lowering the number of available shares in the market.
Companies can choose to repurchase through a tender offer or open market. In this case, the price of shares appears higher than the current market price. Continue reading this blog to understand the concept of share buybacks, its impact and more.
Buyback of Shares Meaning
Share buybacks, commonly known as share repurchase, is a popular method by which a company buys shares of its own from existing shareholders in the market through payment of cash. If the buyback of shares is successful, the total number of outstanding shares automatically reduces in the market.
This, however, contradicts the aim of an Initial Public Offering (IPO), where companies issue new shares to the public to raise funds. Companies issue stock buyback when they no longer need to raise capital from the market. Instead, they have surplus cash and use them to raise investor’s interest.
When a company decides to repurchase its previously-issued shares from existing shareholders, it must abide by the rules and regulations laid out in the Securities and Exchange Board of India Regulations, 2018 and Companies Act, 2013.
How does a Share Buyback Operate in India?
By now, you must have understood the buyback of shares definition. Let’s now explore how this process operates in India:
Announcement
A company first makes an announcement publicly regarding its plan of buying back its own shares. Along with this, other relevant details, such as the number of shares to repurchase and the range of prices, are also mentioned.
Approval
The proposal regarding buying back of shares gets sent to the Board of Directors for approval. Once the company receives approval from the Board of Directors, the proposal is sent to shareholders for final approval.
Open Market
After the company receives the necessary approvals for its proposals, the record date is published further for the buyback. The shareholder’s details mentioned in the company’s record book are all eligible for participation in the offer.
The buyback of shares takes place either through the open market or tender offer, considering the terms and conditions of the company. In case of a tender offer, the company puts offers to repurchase shares at a predetermined price. This offered price is usually higher than the present market price to make the share buybacks more appealing to shareholders.
For open market purchases, the company purchases the shares directly from the market within a specific period.
Payment
The company further takes back all or a portion of its outstanding shares from existing shareholders by paying them in cash. The shares repurchased are then cancelled or kept aside for use in the future.
Primary Reasons for Share Buyback
Continue exploring the main reasons behind why the listed companies repurchase their outstanding shares at certain times. The reasons are:
Companies Have Excess Cash
The presence of idle cash is the primary reason behind the buyback of shares. If a company has excess cash saved from its profits but limited opportunities for growth, it might then opt to repurchase its own shares from its existing shareholders, rewarding them and attracting new investors.
To Raise Earnings Per Share (EPS)
By lowering the number of outstanding shares, a company can offer more value to shareholders via share buybacks. This, in turn, will raise the return on assets (ROA) and earnings per share (EPS). Investors can consider this as beneficial, causing the market prices to increase over time.
For Consolidation of Ownership
Another major reason behind the buyback of shares is raising the control and ownership of shareholders over the company. Repurchasing of shares lowers the total number of outstanding shares, which in turn thereby raises the ownership stake of shareholders who did not participate in the stock buyback offer.
Undervaluation of Shares
Any listed company might choose to buy back shares if the valuation of its stocks is currently undervalued in the market. This undervaluation factor makes a company show confidence in its growth potential to investors, thereby creating positive sentiments in the market.
To Avail Tax Benefits
This is another primary reason for share buybacks. Listed companies who repurchase shares from existing shareholders do not need to pay taxes as their profit incurred gets distributed among existing shareholders. However, they can claim the capital loss incurred as deductions against their capital gains.
This ability to claim capital loss assists companies in lowering their burden of taxes over the period. Moreover, the amount companies end up paying to their respective shareholders for share buybacks are dividends and not capital gains. This process reduces the burden of taxes and benefits a vast majority of investors.
Significant Impact of Share Buyback
Share buybacks create a significant impact on both companies and shareholders. Here is a detailed overview of the implications of share buybacks:
Improvement in Financial Ratios
One of the significant advantages of share buybacks is the gradual improvements in the financial ratios of a company. Be it earnings per share (EPS), return on assets (ROA) or return on equity (ROE), most financial ratios will improve because of the reduction in total outstanding shares and increased value for shareholders.
Shareholders Easy Exit
Shareholders involved in the buyback of shares get a cash return on investment immediately, which appears to be higher than the market offerings. This improves market sentiment as existing shareholders are rewarded and new investors are attracted to future potential rewards.
Reduction in Reserves
Most of the time, listed companies fund repurchasing of shares through their own financial reserves. This lowers the funds available and limits the investment ability of companies in other productive endeavours.
Increased Wealth Creation in the Long Term
Another significant impact of share buybacks is that they create value for shareholders who are willing to retain investments in companies. The rise in key financial ratios and undervaluation can create a positive impact on the market price of the company from which the shareholders can benefit.
Positive Perception of the Market
Being involved in share buybacks showcases the confidence of a company in its financial health and future growth opportunities. Thus, more and more investors can lean towards investing more in the company and nurture its future growth.
Final Words
To conclude, it is vital to gain a thorough understanding of the reasons and impacts of share buybacks. This will help you make strategic decisions. Share buybacks can provide you numerous benefits immediately, but make sure to keep in mind their long-term implications on the ability to create wealth and achieve financial goals.
In recent years, several companies have been involved actively in buyback activities. Thus, it is important for investors to keep an eye on the BSE stock buyback list. Investors can also use the S&P 500 Buyback Index to find out which companies are involved in repurchasing shares in the US market.
