Why do companies buyback their shares?

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Buyback of shares is when the companies purchase back their shares from the shareholders. Outstanding shares are reduced, thereby increasing the price of the stocks. Through this, various financial ratios are improved as well. Stock buybacks happen in an open market or through tender offers. The tender offer will have the number of shares the company wants to repurchase and the amount of the same. While in the open market, the company will buy its shares in the market. Buybacks aid in rebuilding confidence in the market and reduce cash outflows. Let’s check out some of the reasons why companies buybacks their shares.

Stock buyback

Undervalued stocks

A company’s stock price may be more depressed due to a lot of underlying reasons. It can be due to not meeting the expected earnings, or due to an event that might be adverse to the company. So, that is when the company decides to buy back its shares to increase its stock price in the marketplace. It shows that the company has confidence in itself to use its resources to repurchase the stocks and indicate that the stock prices are valued less than the usual.

Better the financial ratios

When a company decides to buy back its shares, the total number of shares listed that is the outstanding shares are reduced. The earnings per share will be higher. Now with fewer shares, the earnings will be higher. When the earnings are higher, the demand is higher. And the investors tend to buy the shares, posing a larger investor value. ROA, ROE and EPS are influenced positively by this.

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Tax privileges

With dividends, when a shareholder receives it, he has to pay ordinary taxes, but with the buybacks, the tax rates are low with capital gains tax. Due to this, the investor would want to invest in the company as it is highly beneficial during this time. In some countries, the dividends are taxed, but the capital gains below a certain point are not. Also, the investor can decide when to sell the shares which are not the case when it comes to dividends as it is in the hands of the manager of the business.

Capital structure

Developments in Capital Structure

When a company decides to buy back its shares, it will be debt-financed during that time and because of the reduction in the taxable income, the capital of the company will be reduced. While the company would be levelling up to look good on the balance sheets, this buyback arrangement will help in changing the capital structure.

Decreased Cash Outflows

The outstanding shares are fewer, which means the investor is holding fewer shares, hence dividends will not be reduced to them. Now the dividends will be less due to fewer shares and it is a great way to protect the capital of the company.

Decreasing Broker costs

Brokers may sometimes tip the money into their pockets instead of the investors and use that for their purposes. So, to prevent such acts, the extra funds will be distributed to the investors when decided by the managers. Though it might be hard for the managers, it might reduce the promoter’s cost due to altering the capital structure. It showcases that the investor’s interests matter to a great extent, thereby gaining their confidence and assisting in the progress of the company.

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Managing dilution

Re issuing the treasury shares will help in managing the dilution of the ownership of the shares, which otherwise would happen if new stocks were issued. When convertible securities and stock options are issued, issuing new shares becomes a major part. But instead of issuing the new shares, reissuing of the shares is immensely profiting.

Some of the examples of share buybacks by the top companies are:
1. In 2012, Reliance Industries announced a share buyback of 10,440 crores. Through the open market route, it brought back shares of just 3900 crores. Also the stock gained by about 8% during that period. Another most significant buyback by a top company was of TCSs’ and also of Infosys.
2. Cairn India also announced a buyback 5725 crores in January 2014. But the company brought back 36,703,839 equity shares, which were 21.48 percent of the highest target. Per equity was 335INR while the minimum was 318 INR that the company paid. And saw a gain of 5.7 percent during the buyback period.

Buying back shares

Benefits of buyback of shares

One major benefit of share buybacks is its versatility. Generally, cash dividends are paid instantly, but with share buybacks, it happens over a long period. There is no hard and fast rule that the buyback should be conducted so the company can decide whether to postpone it or even desert it. The impact will not be similar to the way when there is a cut in the dividends.

Another benefit is :

If the company has excess cash, it can use it to buy back its shares. If there are no plans of extending its business, and instead of the cash remaining unused, it can use the same and benefit from the buyback of its shares. Now, the odds of other companies surmounting a company will be less due to the increase in the promoter stake. Buyback of shares indicates a positive growth of the company, builds trust among the stakeholders, increases the value of the stock and helps in taking better decisions for the company.

Conclusion

Share buybacks can be due to plenty of reasons, and it might be better for the company, or it might not be as well. The value of the shares the investor is holding increases. But that doesn’t mean he is away from any potential risk. Though it is a modern method to return the funds to the investors, investors need to be wary of proposals. However, it shows that the company is doing well. And when the number of stocks is reduced, it indicates that the firm’s stock price is lowered, ensuring a better outlook.

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