In the world of investments, the Stock Market and companies, there are several terms that have never been learned, such as the buyback of shares. If you want to be shareholders of a company, or if you are simply interested in the world of finance, it is good to know about this type of practice.
Today we will tell you what a share buyback is and why companies do share buybacks and how do buybacks affect investors.
When a company buys back its own shares from its investors, it is called share buyback. In a buyback, the company buys shares from its existing investors by giving them a higher price than the market price of Share.
How does Share Buyback affect the company
When the company buys shares from its investors, it increases the share holding of the promoter of the company. And it is considered good for the company. Because it shows that the promoter of the company is totally dedicated about the business and growth of his company. The promoters of the company have agreed that the company will grow further in the future. And because of this the promoters invest in the shares of their own company which is done through Share Buyback. The buyback reduces the number of shares in the market in the market. Which increases the EPS (Earning Per Share) and RE Ratio of the stock, which makes the company financially strong.
What do investors benefit from share buybacks
Buyback is considered good for investors because the company buys shares at a higher price than its investors. Many times the company brings buyback even at 20% to 30% higher price, which gives investors huge profits in a few weeks. The buyback benefits only to investors who are the Existing Shareholders of the company.
Apart from this, investors who have invested in the company for a long time, who do not participate in buybacks, also get the benefit. Because after the buyback process there is an increase in the share price of any company. Due to which the price of the stock keeps rising and the investor also gets a good return on the investment made by him.
Process of Share Buybacks
The company’s management proposes a buyback in front of the board and the company’s board passes the buyback proposal. Also announces record date. A record date is the date on which all investors who have participated in buybacks are required to have shares in their demat account. If there are no shares in the demat account of an investor on the day of record date, then he does not get the benefit of buyback. After the record date, the shares are automatically deducted from your demat account and the money is credited to your bank account. Buyback is brought only when the company’s stock is undervalued or the stock has not performed well in the last few years. Buyback of expensive shares is never done as it causes loss to the promoter of the company.
The buyback is made from a Dutch auction, open market, or through a takeover bid. This mechanism allows companies to compensate their shareholders and can be taken as a type of dividend. By repurchasing their shares, companies reduce the total number of shares circulating on the Stock Exchange. And, at the same time, proportionally increase the profits of each share, being a benefit for the company and shareholders.
Causes of Share Buybacks
The company wants to reduce the number of shares available in the market. As the number of shares decreases, their price is likely to increase. The owner of the company is the one who holds at least 51% of the company. The promoters of the company do Share Buyback to maintain their control over the company. The buyback is done when the company’s reserves and surpluses increase and the company has excess cash.
By buyingback, the company gets its shares and in return, additional cash is distributed to the investors. Many times the company’s profit does not increase even after the good performance of the company. In which case the share price is increased by buying backback.
Are share buybacks positive or negative?
When it comes to knowing if share buybacks are positive or negative. Apple, in 2018 being the most valuable company in the world, made the largest share buyback in history for 100 billion dollars. Although Goldman Sachs (Investment banking company), claimed that in 2018. The investment authorized by boards of directors to buyback shares would be 1 trillion dollars.
Why do companies buy back shares instead of paying dividends?
The buybacks have more flexibility than dividends. Dividends on the one hand offer the benefit of a guaranteed return. Share buybacks push up the price of the share, but it does not guarantee that the value will last in the market.
Something to clarify is that although it can generate a high demand generating an increase in the share price. But share buybacks do not in themselves increase the value of the company; there are other factors too.
The consequences and implications for investors-shareholders and the company itself are linked to the benefits. And also increases the cost of shares, this helps the company to obtain financial growth, either internally or externally.
Something to consider with all of the above is that the owners themselves become shareholders of the company. One of the main objectives of a company is to generate the highest return for its investors that it can. As well as having much of their shareholdings for its business objectives.
