Share Buyback: Know about benefits, method & Purpose of Buyback

17 Apr 2020  Read 4656 Views

A repurchase, also known as a share buyback, occurs when a company buys its outstanding shares to reduce the number of shares available on the open market. Companies repurchase shares for a variety of reasons, such as increasing the value of the remaining shares available, reducing the offering or preventing other shareholders from participating in the control.

PURPOSE OF SHARE BUYBACK

A buyback allows companies to invest in them. Reducing the number of shares outstanding in the market increases the proportion of shares owned by investors. A company may feel that its shares are undervalued and make a buyback to provide investors with returns. And since the company is optimistic about its current operations, a repurchase also increases the proportion of earnings that a share is allocated. This will increase the stock price if the same price/earnings (P / E) ratio is maintained.

The repurchase of shares reduces the number of existing shares, making each one worth a higher percentage of the corporation. The earnings per share (EPS) of the shares, therefore, increase, while the price/earnings (P / E) ratio decreases or the price of the shares increases. Repurchase of shares demonstrates to investors that the company has sufficient cash for emergencies and a low probability of economic problems.

METHODS OF SHARE BUYBACK

BUY IN THE OPEN MARKET

In this method of share buyback, the company buys its shares in the market. This transaction takes place through the company's brokers. This buyback program takes place over a long period, as it is necessary to buy a large block of shares. The company has no obligation to carry out the repurchase program after the announcement. The company has the option to cancel it. Also, you can make changes to the repurchase program according to the company's situations and needs. If this method is effectively implemented, it can be very economical.

FIXED PRICE OFFER

In this method, the company makes an offer to buy a non-fixed one. of shares at a fixed price for its shareholders. The price offered by the company is above the current market price. Shareholders have the option to resell the stock or retain the shares. Interested shareholders send no. of shares that they are willing to sell back to the company. If a total no. of shares exceeds the shares required by the company, the shares are proportionally repurchased. This method can be conducted quickly, but it can be more expensive than buying shares back on the open market.

OFFER DUTCH AUCTION OFFER

This is very similar to the fixed price offer. Instead of specifying a fixed price, the company offers a variety of prices to shareholders. The minimum price is above the current market price. For example, a share is currently trading at $ 100. The company offers to buy back 2 million shares in the range of $ 101 to $ 103. Investors will offer no. of shares and the minimum price at which he/she wants to sell the shares. The company will start qualifying bids starting at $ 101 and move up to higher prices until the fixed number requirement. of shares is fulfilled. If the $ 2 million stock requirement is met at $ 102, every qualified bidder will receive $ 102. Bids over $ 102 will be rejected. If the total bid of $ 101 and $ 102 exceeds the stock requirement, the shares will be distributed proportionally.

PURCHASE BY DIRECT TRADING

In this method, the company only addresses shareholders who own a large block of shares. They receive a premium above the current market price. This is a more logical approach, as the company can negotiate directly with large shareholders.

ADVANTAGES OF SHARE BUYBACK

  1. The repurchase of shares is flexible. The share buyback program is carried out over a long period, unlike cash dividends that need to be paid immediately. 

  2. Some countries have a lower capital gain tax rate compared to the dividend tax rate. The repurchase of shares will be taxed in the capital gain tax category. 

  3. The repurchase of shares is usually a positive sign because the company realizes that the shares are undervalued and trusts its growth prospects. There may also be a possibility that the company may not have lucrative reinvestment opportunities, so it is buying back the shares.

DISADVANTAGES OF STOCK PURCHASE

  1. The repurchase of shares increases some indexes such as EPS, ROA, ROE, etc. This increase in the indexes is not due to the increase in profitability, but to the decrease in the free float. It is not an organic profit growth. Therefore, the repurchase will show an optimistic image, removed from the company's economic reality.

  2. While management has better access to company information, chances are they may also make mistakes when evaluating the company. If the repurchase is carried out to support the undervaluation, the company overestimated prospects. This error will render the entire repurchase process useless.

  3. When a company buys its shares back from shareholders, the number of outstanding shares of the company decreases and the ownership of existing shareholders increases.

How does it affect shareholders?

Suppose there is a company 'X', with 200 shares outstanding. You own 10 shares of X, so your percentage stake is 5%. X now repurchases 100 outstanding shares from shareholders and some of the shareholders sell their shares. At the end of this year, although the company's value decreased by the amount used to repurchase shares, its percentage share rose to 10%.

The repurchase can be good or bad for shareholders, depending on the fair value of the shares and the price of the repurchase.

Suppose that in the example above, before the repurchase, the fair value of X is Rs 20000. The fair value per share would be Rs 100. The current trading price of X shares is Rs 150, which means that the share is overvalued. X borrows Rs 15,000 and buys back 100 shares at the current price. Now, the fair value of X has dropped to Rs 5000 (debt = Rs 15000) and the number of outstanding shares is 100. Therefore, the fair value per share has dropped 50% to just Rs 50, from Rs 100 previously. In that case, the repurchase destroyed the value for existing shareholders.Affect on the company?

A share buyback has an obvious effect on a company's income statement as it reduces its outstanding shares. But it also affects other financial statements.

On the balance sheet, a share buyback will reduce the company's cash reserves and, consequently, its total asset base, by the value of the money spent on the buyback. The repurchase will simultaneously reduce the liability's equity by the same amount. As a result, performance metrics like return on assets (ROA) and return on equity (ROE) generally improve after a share buyback.

Companies generally specify the amount spent on stock repurchases in their quarterly earnings reports. The amount spent on share repurchases can also be obtained in the Cash Flow Statement, in the Financing Activities section, as well as in the Statement of Changes in Equity or the Statement of Retained Earnings.

How can investors apply for shares buyback?

Stock repurchases approved by companies allow investors to add value to the amount invested in these scripts. As companies, throughout the process, distribute surplus surpluses or cash reserves with them to their shareholders, repurchasing outstanding shares back with a premium when they no longer have expansion plans. Two decent buybacks will be offered shortly, and if you follow the financial markets, you may be tempted to distribute this stock buyback offers to earn some extra cash.

Discover the bidding process for your shares in the buyback scheme 1. Just as you buy shares using the Demat account, in the same way, that you can bid shares during the offer, visit the Demat account online. If the repurchase offer has been opened by the company, you will see it flash under an offer to sell or as a separate repurchase option.

2. You need to check the price fixed for the repurchase to confirm the return that the offer will pick you up. At the same time, for how many days the offer remains valid, as in that period only the shares will be repurchased by the company.

About the Author: Ausaf Ahmed | 18 Post(s)

Ausaf is a 2nd-semester student who is pursuing Accountancy Honours. He has a joyful character and is a very curious boy who always tents to learn new things especially in travel and finance background. 

Liked What You Just Read? Share this Post:

Finology Blog / Invest / Share Buyback: Know about benefits, method & Purpose of Buyback

Wanna Share your Views on this? Comment here: