What is Share Buyback?

Listed companies often initiate several corporate actions that impact their shareholders. One of the many actions that these companies take includes share buybacks. It is a major decision with wide-ranging implications for the companies and their shareholders. But then, what is a stock buyback and why do companies opt for such a strategy?

In this article, we will explore the meaning of share buybacks, the reason for initiating such an action, and the nature of its impact.

Share Buyback Meaning

A share buyback, also known as a share repurchase, is the process through which a company purchases its own shares from its existing shareholders by paying cash. A successful share buyback reduces the number of outstanding shares in the market and is in direct contrast to an Initial Public Offering (IPO), where a company issues newly created shares to the public.

A company that has decided to repurchase its shares from its existing shareholders must strictly adhere to the rules and regulations laid out in the Securities and Exchange Board of India (Buy-back of Securities) Regulations, 2018 and the Companies Act, 2013.     

How Does the Buyback of Shares Work in India? 

Now that you are aware of what share repurchases are, let us briefly look at how this process works in India. 

• Announcement

The company makes a public announcement making its intention of buying back its shares known along with key details such as the number of shares to be repurchased and the price range. 

• Approval

The buyback proposal is then sent to the Board of Directors for approval. Once the Board of Directors approve it, the proposal is then sent to the shareholders for their approval.   

• Tender Offer or Open Market

Once the necessary approvals are obtained, the company publishes the record date for the buyback. All shareholders appearing on the company’s books on the record date will be eligible to participate in the offer. 

The share buyback is conducted either through a tender offer or the open market, depending on the company’s policy. In a tender offer, the company offers to purchase the shares at a certain specific price. This offer price is usually set higher than the present market price to make the buyback more attractive to shareholders. In an open market purchase, the company buys shares directly from the market over a certain period.

• Payment

The company takes back the shares tendered by the existing shareholders and pays them in cash. The repurchased shares are either cancelled or safely kept aside for further issues that may happen in the future.

Read More About How to Apply for Buyback of Shares?

What are the Reasons for Buyback of Shares? 

Now that you know how the buyback of shares works in India, let us briefly look at a few reasons why listed companies may choose to repurchase their shares. 

• Excess Cash 

The availability of surplus idle cash is the major reason for the buyback of shares. If a company has excess cash but limited investment or growth opportunities, it may choose to repurchase its shares from its existing shareholders. 

• Consolidation of Ownership

Another key reason for the buyback of shares is to increase the control and ownership major shareholders have over the company. Share repurchases reduce the total number of outstanding shares, which increases the ownership stake of shareholders who do not participate in the buyback offer.  

• Increase Earnings Per Share (EPS)

By decreasing the number of outstanding shares, share buyback offers can increase the return on assets (ROA) and earnings per share (EPS). Investors could potentially view this as a positive sign, leading to an increase in the market price.   

• Undervaluation

A listed company may buy back its shares if it firmly believes its stock is undervalued. This signalling of undervaluation can make the company seem confident in its future growth potential to prospective investors and generate positive market sentiment. 

• Tax Benefits

A major reason for the buyback of shares is the tax benefits on offer. Listed companies repurchasing shares from their existing stockholders need not pay any tax on the same and can claim the costs incurred towards such purchase as a capital loss. 

The ability to claim capital loss can help companies reduce their tax burden significantly. Furthermore, the amount companies pay their shareholders for share buybacks will be treated as dividends and not capital gains, which can benefit a vast majority of investors.     

What is the Impact of Share Buyback? 

The impact of share buybacks is far-reaching and affects both the companies opting for it and their shareholders. Here is a quick look at the implications of this corporate action.  

• Improved Financial Ratios

One of the most important advantages of the buyback of shares is the resulting improvement in the company’s financial ratios. From earnings per share (EPS) and return on assets (ROA) to return on equity (ROE), most of the key financial ratios will see an improvement due to the reduction in the total outstanding shares due to the share repurchase.   

• Reduction in Reserves

Listed companies often fund share repurchases using their accumulated financial reserves. This reduces available funds and limits the companies’ ability to invest in more productive endeavours. 

• Easy Exit for Shareholders

Shareholders who participate in share buybacks get an immediate cash return, which often tends to be more than what the market offers.    

• Increased Long-Term Wealth Creation 

Another key impact of share buybacks is the enhanced long-term wealth creation ability for shareholders who choose to retain their investments in the companies. The increase in key financial ratios and indication of undervaluation can have a significant positive effect on the company’s market price which the shareholders can benefit from.   

• Positive Market Perception 

A share buyback indicates the company is confident in its financial health and future growth prospects. This could potentially lead to more investors flocking to invest in the company, fueling further growth in the share price.

Conclusion

As an investor, understanding the reasons and impact of share buybacks is crucial since it can help you make informed decisions should the companies in your portfolio opt for such a financial strategy. That said, while buybacks can offer immediate benefits, remember to assess the long-term implications on your wealth creation ability and financial goals before deciding to participate in the offer.

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