Buyback of Shares: Meaning, Methods and Reason

Let's now explore the next corporate manoeuvre, which involves repurchasing shares - commonly called a Share Buyback.

When a company decides to buy back its own shares, it has the flexibility to acquire the stock either directly from its shareholders or by making purchases on the open market.

Importantly, shareholders are not compelled to sell their stock back to the company, and the buyback doesn't selectively target any specific group of holders—it's an open invitation available to all investors.

This move can have different effects. For the company, it can be a way to invest in itself, suggesting it believes the company will do well in the future or that its shares are currently undervalued. Reducing the total number of shares can also make the earnings per share look better, making the remaining shares more valuable.

For people who own shares, a buyback can be a chance to sell some of their shares, often at a good price. But they might also choose to keep their shares, hoping the value will go up more over time.

Share buybacks also change the company's debt and equity, which can impact its financial strategies. Companies need to think carefully about whether a buyback is the best use of their money compared to other options like paying off debt or investing in new projects.

The buyback of shares has become more predominant over dividends over the last few years. For instance, Wipro announced a buyback of shares worth ₹12,000 crore, with the record date set for June 16, 2023, and the buyback open date on June 22, 2023. The buyback price was fixed at ₹445 per share​. TCS also announced a share buyback in 2023, with the board approving the buyback of up to 4,09,63,855 equity shares for an aggregate amount not exceeding ₹17,000 crore

There's a lot of debate about share buybacks. Some people think they're a good way for companies to give money back to shareholders. In contrast, others worry that they can be used to artificially push up share prices and earnings per share, diverting money away from other investments that could help the company grow in the long run.

Share buybacks are, thus, complex tools that companies use for various reasons. Their implications for the company and its shareholders vary. Ultimately, it’s about whether this move fits the company's overall strategy and financial health.

Methods Of Buyback

Below are how companies can make a buyback offer:

• Tender Offer:

In a tender offer, the company offers to the existing shareholders to sell a specific number of shares at a fixed price. Shareholders can choose to participate or abstain from the offer. The fixed tender offer is typically completed within a short time.Applying for a buyback in a tender offer incurs charges of ₹20 plus GST per order. These charges are non-refundable, regardless of the order's acceptance, rejection, or failure.

• Open Market Purchase:

Another way companies can repurchase shares is directly from the stock market. This approach gives the company the leeway to choose when and how many shares to buy back. Since the goal is often to acquire a large number of shares, this method might spread over a longer timeframe.

• Dutch Option Tender Offer:

In this option, the company first sets a price range and then invites shareholders to submit their bids, indicating the price at which they are willing to sell their shares. The shareholders then indicate their bids, stating the quantity of shares and the minimum price at which they are willing to sell the shares.  The company assesses the bids and determines the appropriate price from the price range to close the buyback program.

• Direct Offer:

Sometimes, a company might choose to approach one or several shareholders directly with an offer to buy back shares. Typically, this offer includes a premium over the market price as an incentive for the shareholder(s).

Why Do Companies Buy Back Shares?

Ever wondered why a company would buy back its own stock that was once issued by them? There could be various reasons for repurchasing of stock. Let's take a look at a few major reasons:

• Addressing Underpriced Shares:

Companies often initiate buybacks when they believe their stock is selling for less than it's worth. By purchasing their own shares, they reduce the supply in the market, which can help push up the stock price, benefiting the value of the remaining shares.

• Boosting Shareholder Value:

A key motive behind share buybacks is to boost shareholder value. By decreasing the total number of shares available, the Earnings Per Share (EPS) may rise, potentially making each share more valuable.

• Putting Excess Cash to Work:

Companies sitting on large cash reserves without immediate investment needs might choose to buy back shares. This is a way to use this surplus cash in a manner that can benefit shareholders.

• Refining the Capital Structure:

The balance between debt and equity in a company's finances, known as the capital structure, can be fine-tuned through buybacks. This might enhance shareholder returns or adjust the company's equity proportion.

• Tax Benefits for Shareholders:

Compared to dividends, which are typically taxed as income, the capital gains from selling shares back to a company can often be taxed more favourably. This makes buybacks a tax-smart way for companies to return money to shareholders.

• Defensive Measure Against Takeovers:

To thwart potential hostile takeovers, companies might buy back shares, thus reducing the number of shares available for acquisition and making it more expensive for a takeover to succeed.

• Managing Employee Stock Plans:

Buybacks can also be used to manage the dilution of shares due to employee stock options. By repurchasing shares, companies can balance out the issuance of new shares to employees, maintaining a strategic distribution of equity within the company.

Advantages of Stock Buybacks for Investors

• Share Price Boost:

  Stock buybacks can yield a short-term benefit for investors by reducing the number of shares in circulation, thereby strengthening share prices.

• Increased Dividends:

Following a buyback, companies may be able to enhance dividend payments as there are fewer shares to distribute dividends among.

• Enhanced Earnings Per Share:

With fewer shares in the market, the EPS figure typically increases when the company reports profits. This can surpass market expectations and contribute to a higher stock price.

• Efficient Cash Utilisation:

Removing excess cash from a company's reserves, especially if it's earning minimal interest, can enhance overall performance by reallocating funds to more profitable activities.

• Positive Investor Sentiment:

Investors often view Stock buybacks positively, signalling that the company believes its stock is undervalued. This perception can trigger an upward movement in stock prices.

Disadvantages Of Buyback

• Reduction in Available Cash:

When a company engages in share buybacks, it utilises cash that could otherwise be deployed for new projects or debt repayment. This reduces the company's financial flexibility and may pose challenges during a downturn. 

• Potential EPS Manipulation:

Buybacks at low stock prices can artificially inflate EPS, enhancing the stock's appeal to investors. However, this may not truly reflect the company's underlying financial strength.

• Challenges for Shareholders:

If a company buys back its shares at a premium, shareholders who sell their shares during the buyback might benefit from the immediate gain. However, those who choose not to participate and hold onto their shares could face risks if the company's share price declines after the buyback. As a result, the remaining shareholders might find the value of their investment reduced in the aftermath of the buyback, especially if the market perceives the buyback as a short-term boost rather than a reflection of the company's long-term financial health.

Bottom Line

Stock buybacks are a versatile financial tool that serves as an advantage and a consideration for companies and investors. As with any financial strategy, the effectiveness of stock buybacks depends on various factors, including market conditions, the company's financial health, and its commitment to long-term value creation. 

By considering these factors and weighing the potential benefits against the risks, investors can make informed decisions in navigating the dynamic landscape of stock buybacks.

Now that we've explored the dynamics of stock buybacks and their impact on financial metrics and market behaviour, let's turn our attention to another crucial aspect of corporate strategy – Mergers and Acquisitions (M&A) in the next segment.