Updated Mar 23, 2022

What is Shares Buyback?

What is Shares Buyback?

Introduction

Share buyback refers to the act performed by a company that involves buying or purchasing the company’s shares back from its investors. It is also referred to as a share repurchase.

Methods of Shares Buyback

Open market

Here the company purchases its shares from the market. The transaction of purchasing the shares takes place with the help of the company’s broker. The re-buying of the shares is a very time-consuming procedure because the company needs to buy large blocks of shares back. The company has no obligation to go ahead with its decision of repurchasing even after the announcement.

Fixed-price

This method is known as a fixed price tender offer; here, the company makes an offer to the shareholders to purchase a fixed or certain number of shares, and those shares need to be bought at a fixed price. The price that is offered is above the current market price. Here the shareholders hold power to decide on giving or holding back the shares. This method might prove more expensive for the company than purchasing the shares from the open market.

Dutch auction

Dutch auction tender offer is quite the same as fixed price tender offer. Here, in place of indicating a fixed price, the company has the option of offering a range of prices to its shareholders. However, the minimum offered amount needs to be above the current market price.

Direct negotiation

The company could be involved in re-buying its stocks through a method where direct negotiation takes place. The company approaches the shareholders but only those who hold a large chunk of the shares. The company has to be ready to pay such shareholders a premium that is well above the current price in the market. This method is thought of as a more logical way for the company to buy back its shares as the company can negotiate directly with the major shareholders.

Advantages of shares buyback

Suppleness

The nature of share buyback is considered to be very flexible. The programme for the re-buying of the shares goes on for a very long time, unlike the cash dividends requirement of paying immediately. The company has no obligation of mandatorily conducting the re-buying programme; it has the choice of letting it go. The shareholders, too, have no obligation of selling their shares back to the company; they can opt out.

Taxes

Several countries have lower capital gains tax rates when compared to the dividend tax rates. The re-buying of the shares comes under the capital gain tax category and is therefore taxed accordingly. The investors are seen to be more interested in share buyback than cash dividends when deciding on types of dividend in the countries that offer lower capital gains tax rates.

Signals

For most of the time, a share buyback is a positive signal as the company observes the shares to be undervalued, and the company is very confident about the growth’s prospects. However, there is also a chance that the company is re-buying the shares because there are no profitable reinvestment opportunities. This is taken as a negative signal for the capital growth of investors. The investors could get a fair idea about the actual condition of the company and where it is headed to.

Financial Ratios

A reduction in the total number of shares would take to the higher ratios like- DPS, EPS, ROE etc. The profit stays unaffected, and thus the company finds the increased profitability on each share.

Disadvantages of the share buybacks

Valuation

The management of a company is more informed about the condition and other details of the company; there still is a probability that the management goes wrong and might value the company wrongly. For instance- if a company goes for buyback to support the undervaluation, there are chances that the company has overestimated the prospect. Thus the whole procedure of the buyback becomes futile.

Ratios

Some ratios like EPS, ROE, ROA etc., can be boosted with the help of share buyback. The ratio increase is not necessarily because of the rise in profitability, but the reason can be a decrease in outstanding shares. Thus the profit growth is not organic. The buyback, therefore, can’t be considered as the one showing the real economic reality of the company.

Conclusion

The shares buyback is thought of as returning money in a tax-efficient manner to the shareholders. The re-bought shares are considered to be cancelled, although there are chances of keeping those shares for redistribution.