In the last few years, we have seen a number of companies announcing a buyback of shares. But the question that arises is why does a company feel the need to go for a buyback? And how does buyback happen? We have answered all your queries in this article. But before we get into the nuances of buyback, let us understand what it is.
What is buyback?
A company may plan to buy some proportion of its shares from the existing shareholders when they have extra cash and can’t find an ideal investment avenue. This process of buying back its own shares is known as buyback. It is a corporate action wherein a company announces buyback to acquire shares at a price higher than the current market price from the existing shareholders in a given timeframe.
There are several reasons due to which a company may announce its buyback. A few of them are mentioned below:
- Availability of surplus cash but fewer investment avenues
- Considered as a more tax-effective option
- Improves the ROE (Return on Equity) and EPS (Earnings Per Share) as the number of shares are reduced
- Signals that a stock is undervalued
Click here to know about the buyback of shares in detail.
Types of buyback of shares
Below-mentioned are the most common methods through which a company can buy back shares in India.
1. Tender Offer
Under this route, the company buys back its shares from the existing shareholders on a proportionate basis within a stipulated time period.
2. Open Market (Stock Exchange Mechanism)
In the Open Market Offer, the company buys back its shares directly from the market. This buyback process consists of buying back a large number of shares and is executed via the company’s brokers over a period of time.
To know more about the types of buybacks, read here.
Tender offer vs open market offer
From the above-mentioned methods, tender offer, and open market offer (stock exchange mechanism) are the most popular buyback methods in India. Read on to know the characteristics of both the buyback mechanisms.
*In Open Market Offer, the company has an option to close the buyback when it achieves the maximum buyback size or uses at least 50% of the amount set aside for buyback, whichever is earlier.
Conclusion
The process of buying back its own shares either from the shareholders directly or through the market is known as buyback. A company can enjoy multiple benefits if it opts for a buyback such as an increase in share price, improves key financial ratios of the company, optimum utilization of the surplus cash, and more.
However, as an investor, you must not get lured by the premium offer price by the company. As a responsible investor, you must consider other aspects before applying for a buyback like why the company has announced it, its growth prospects, and what are your goals and risk appetite. Once you have made your decision to apply for a buyback, click here to know how you can apply for a buyback of shares.
