In the stock market in India, share buybacks are a relatively new concept that has recently gained traction. The SEBI (Buyback of Securities) Regulations 1998 govern the buyback of shares and establish criteria for the process.
In this blog, let us analyze the definition of stock/ share buybacks, the reasoning behind the share buyback, techniques, and benefits of the share buyback for the companies.
What is Share Buyback?
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As per the definition mentioned on the BSE official website–
“A share buy-back is a corporate action in which a company purchases its existing shareholders’ shares at a price higher than the market price. When it buys back shares, the number of shares on the market reduces.”
In a nutshell, repurchase of shares or share buyback in the Indian stock market refers to a company buying back its own shares that were previously issued.
It is a corporate action in which a company makes a public notice about a repurchase offer to existing shareholders within a certain timeframe. The company announces a buyback offer that is significantly greater than the current market price.
Why do companies buy back their shares or stocks?
Repurchase of shares or share buyback can be done for a variety of reasons, but the most common rationale is that the stock is undervalued and the firm wants to enhance demand.
Share buybacks reduce the number of shares in circulation, increasing the value of the stock and earnings per share (EPS).
Now you might ask what is earnings per share or EPS? To calculate a company’s earnings per share (EPS), the company’s net income is divided by the number of shares in circulation. EPS will automatically rise as the number of shares is reduced.
Suppose the EPS of a specific company is INR 100. If the company’s net income is INR 1000000 and there are 10,000 shares outstanding. However, if the corporation buys back any of its stock, the EPS will rise.
By informing the public that the company has adequate cash to repay its investors, share repurchases can create a favorable impression. However, it may foster a pessimistic view by supporting the assumption that the company has little room for expansion.
We’ve recently witnessed a spike in the company’s buyback offers.
Do you know why companies purchase back stock that they previously issued? Various things influence a business to announce a stock buyback.
Undervalued Stock
When management believes its stock is undervalued, they use the buyback strategy to correct the price. The stock buyback reduces the number of shares on the market, hence raising the price of the remaining shares.
Cash surplus but few project opportunities
A corporation with free reserves but few project opportunities would prefer to buy back its stock.
Tax-efficient way of Rewarding stockholders
In the case of a share buyback, only the company is liable for the buyback tax. The investor is exempt from capital gains on income from share repurchases. As a result, share buybacks are a tax-efficient way of rewarding shareholders.
Dividends vs. Share Buyback
When it comes to stock investing, companies reward their investors in two ways: dividends and stock buybacks. Many businesses use both to keep their shareholders happy.
In its most basic form, the dividend is a specific amount per share paid to shareholders from the distributable surplus. The dividend amount is distributed to all eligible shareholders in proportion to the number of shares held and the amount of dividend declared by the company.
A company that declares dividends are considered to be cash-rich, and it also sends the message that the company is profitable. A high dividend-paying company is generally preferred by shareholders because it provides them with a consistent source of income.
Aside from other metrics such as the Price to Earnings (P/E) ratio and Price to Book (P/B) value, investors and analysts consider a company’s dividend yield to be an important metric for determining its worth.
A share buyback happens when a company repurchases or ‘buys back’ its shareholders’ shares. A share repurchase offer is optional for the company’s shareholders.
When the company makes the buyback offer, only shareholders who want to receive funds can tender or relinquish ownership of the required number of shares to the company.
A share buyback is another method of rewarding shareholders. The share buyback is offered at a reasonable premium to the current market price to make it more profitable for shareholders.
The company’s buyback at a higher price or premium also instills confidence in shareholders because it shows that the company has strong cash flows, substantial balances, and bright future profitability prospects.
Conclusion
Share buyback or share repurchase in the Indian stock market is an effective technique for management to improve the company’s low share price while also reducing share capital.
It’s important to remember that as an investor, you should consider the objective and timing of a buyback, as well as the company’s overall financial status. Finally, a shareholder should review all of his positions before purchasing shares in a firm that is undergoing a repurchase.
