What is Share Buyback/Repurchase?
Share buyback or repurchase is the practice where companies decide to purchase their own share from their existing shareholders either through a tender offer or through an open market. In such a situation, the price of concerning shares is higher than the prevailing market price.
When companies decide to opt for the open market mechanism to repurchase shares, they can do so through the secondary market. On the other hand, those who choose the tender offer can avail the same by submitting or tendering a portion of their shares within a given period. Alternatively, it can be looked at as a means to reward existing shareholders other than offering timely dividends.
However, company owners may have several reasons for repurchasing their stocks. Individuals should make a point to find out the underlying causes to make the most of such decisions and also to benefit from them accordingly.
What can be the reasons for Share Buyback?
There may be several reasons why a company opts for a stock buyback. However, the list below highlights the most common reasons for the same.
When There Is Excess Cash but Not Enough Projects to Invest In
Companies issue shares to raise equity capital and expand their venture, but often such a practice does not prove to be of much use. Similarly, keeping excess money at the bank is more like a truncated cash flow offering liquidity over the ideal requirement. Hence, instead of piling on cash reserves, companies with robust financial standing tend to make the best possible use of the cash available through a stock buyback.
It is a Tax-effective Rewarding Option
When compared to dividends, share buybacks are more tax-effective for both companies and their shareholders. To elaborate, stock buybacks are subjected only to DDT, and the amount of money is deducted before distributing the earnings to the surrendering shareholders. On the other hand, dividends are taxed at 3 different levels.
To Consolidate Hold Over the Company
Often when the number of shareholders of a company exceeds the manageable limit, it becomes challenging for the entity to reach a decision unanimously. Additionally, it may result in a power struggle within the company and among the shareholders with voting rights. To avoid or aggravate such situations, company board members often resort to share buybacks and plan to consolidate their hold over the company by increasing their voting rights.
For instance, OYO Rooms’ attempt to repurchase shares worth $1.5 billion from Lightspeed and Sequoia Capital is one of the most recent examples of buyback of shares in 2020. The success of such a proposal would increase the company CEO’s current shareholding from a meager 10% to 30% and strengthen his hold over the company.
To Signal that the Stock Is Undervalued
When a company decides to buy back its shares, it may also indicate that the company considers its shares to be undervalued. Besides serving as a remedy for the situation, it also helps to project a positive picture of the company’s prospects and its current valuation.
Other than these, stock buybacks may be prompted to improve companies’ overall valuation or to reward their existing shareholders.
What Is the Impact of Share Buyback on stock price?
The following pointers highlight what are buybacks impacts that are faced by a company’s different financial aspects.
Effect on Earnings Per Share (EPS)
Repurchasing a company’s shares lays a direct impact on its EPS by increasing the ratio significantly. It mainly happens because the net income tends to remain the same, while the total number of outstanding shares reduces post repurchasing.
Effect on Financial Statement
The money spent to repurchase company stocks would be recorded in the business’s earnings report and can also be found in the statement of cash flow under the head ‘financial activities as well as the statement of retained earnings.
Besides influencing the income statement of a company, the impact of share buybacks can be noticed in other financial statements as well.
For instance, in the Balance Sheet, the record of a company’s cash holding would reduce and in turn, would lower its total assets. Simultaneously, the amount of shareholder’s equity would also undergo a reduction. Notably, such a reduction would help improve performance metrics like Return on Equity (ROE) and Return on Asset (ROA).
Effect on the Company’s Portfolio
Usually, companies who have faith in their prospects indulge in the practice of repurchasing their company shares. Such a display of confidence is received positively by potential investors and existing shareholders and helps earn their trust significantly. In turn, it helps the company to enhance its market reputation and facilitates an increase in its share value naturally. All of this directly helps improve the venture’s portfolio significantly.
Effect on Increasing Shareholder Value
Business owners who opt for share repurchase are more likely to enhance their EPS significantly, and that too much faster than operational improvements. Investors scouting for profitable investment options tend to acknowledge companies with steady EPS as a better income-generating avenue with enhanced growth potential.
Further, it is believed that companies who are capable enough to repurchase their shares from shareholders have a grand market presence and robust pricing power. Hence, the practice of share repurchase not only helps to project a positive image of the company in the market but also comes in handy for potential investors.
What Does Share Buyback Signify?
Investors often believe that the declaration of upcoming buyback of shares signifies that the company’s prospect is profitable. Further, it is believed to influence the overall stock price of the company. For instance, investors often believe that repurchasing shares from shareholders is a probable indication of the acquisition of big companies, the launch of new and improved product lines, etc., among others.
All in all, it can be said that share buyback signifies that the stock valuation of a company is going to increase shortly. Notably, hinting at such positive prospects further helps to draw the attention of investors who wish to make the most of such favourable circumstances.
Regardless, certain companies may resort to this practice when their stock valuation decreases. It is mainly done to prevent their capital from eroding further.
As a means to identify the actual motive behind the stock buyback, investors should factor in a few things like the current trends in stock prices and current earnings per share. Additionally, it will help them understand the implications of such a decision.
Are there any charges that are levied for applying in Buyback?
Yes, customers applying for Buyback through ICICIdirect will be charged cash brokerage as per their mapped brokerage plan. GST and other statutory charges will also be charged
Where can I check the upcoming Buybacks?
You can check the upcoming Buybacks in the below mentioned link
https://www.icicidirect.com/ipo/buybacks
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