Home Learn What is Share Buyback? Learn the Benefits, Disadvantages & Reasons Why a Company Repurchases Shares

What is Share Buyback? Learn the Benefits, Disadvantages & Reasons Why a Company Repurchases Shares

What is Share Buyback? Learn the Benefits, Disadvantages & Reasons Why a Company Repurchases Shares
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Have you ever wondered how companies manage their finances and enhance shareholder value? Well, that’s where the concept of ‘share buyback’ comes into play. In this intriguing financial maneuver, companies use their surplus funds to buy back their outstanding shares from shareholders, effectively reducing the number of shares available in the market. But why do companies choose to do this? Let’s delve into the significance of buybacks in the corporate world and explore the various reasons behind this strategic move. Now, let us find out what buyback of shares means.

What is Share Buyback or Share Repurchase? 

A share buyback is also known as a stock buyback or share repurchase. In simple terms, the share buyback meaning is a financial strategy adopted by companies to repurchase their outstanding shares from the market or existing shareholders. As unlikely as it may sound, this share buyback holds its own importance. 
Thus, when companies choose the open market approach to buyback shares, they can execute the repurchase process through the secondary market. In the past few decades, share buybacks have become more popular than dividends as a preferred method to distribute cash to shareholders. While smaller companies might opt for buybacks, it is the blue-chip companies that are more inclined to do so, mainly due to the associated expenses. Now that we know the buyback share meaning, let’s see why companies buy back shares.

Why do Companies Buy Back Shares?

Buyback of shares in India can contribute modestly to the overall positive impact on the economy. Despite companies raising equity capital by issuing common and preferred shares, it might appear counter-intuitive for a business to decide to return that money. However, there are various reasons as to why companies buyback shares as it could be beneficial for them. 

However, the list below highlights the most common reasons for the same.

Increases Earnings Per Share (EPS)

When a company buyback its shares, the number of outstanding shares decreases. This means that the company’s earnings are spread over fewer shares, which results in higher EPS.

Returns Capital to Shareholders

Share buybacks are a way for companies to return capital to shareholders without having to pay out dividends. This can be a good option for companies that have excess cash on hand and do not have any other good uses for it.

Signals the Company’s Stock is Undervalued

When a company participates in a share buyback at a premium to the current market price, it is signalling to investors that it is an undervalued stock. This can lead to an increase in the share price as investors buy into the company’s belief.

Reduces the Number of Shares Outstanding

Share Buybacks can make the company more takeover-resistant. If there are fewer shares outstanding, it would be more expensive for another company to acquire the target company.

To Improve Financial Ratios

Some financial ratios, such as return on equity (ROE) and debt-to-equity ratio, can be improved by share buybacks. This can make the company look more attractive to investors and creditors.

What are the Different Types of Share Buybacks? 

Let’s have a look at the different types of stock buybacks that one should know: 

  • Tender Offer: In a tender offer, a company extends an invitation to shareholders to sell a specific number of shares at a fixed price. Shareholders have the choice to either accept the current buyback offers and sell their shares or retain them.
  • Open Market Repurchase: Through an open market buyback, a company buys back its shares gradually over time from the open market. The share prices may fluctuate depending on prevailing market conditions.
  • Dutch Auction: Employing a Dutch auction, a company sets a price range and allows shareholders to submit bids indicating the price at which they are willing to sell their shares. The company then purchases the shares at the highest price that matches the market demand.
  • Direct Negotiation: The least common type of buyback is direct negotiation, where a company engages in one-on-one negotiations with individual shareholders to repurchase their shares.

Let us now explore the advantages and disadvantages of buyback of shares.

What are the Advantages of Buyback of Shares?

As unusual as it may sound, there are multiple benefits of buyback of shares. Some of the share buyback benefits have are:

  • Boosts Share Price: Reducing the number of outstanding shares can increase earnings per share and, in turn, elevate the stock price.
  • Potential Tax Benefit: Stock buybacks may offer a more tax-efficient way to return value to shareholders compared to dividends.
  • Prevents Dilution: Offset the potential dilution of existing shareholders’ ownership caused by the issuance of new shares.
  • Provides Exit Option: For shareholders looking to exit, buyback tender offers a way to sell their shares directly to the company at a fair market price. It one of the great advantages of buy back of shares.

What are the Disadvantages of Share Buyback?

Share buybacks are a popular way for companies to return capital to shareholders. However, there are also some potential disadvantages to share buybacks. Here are some of the most common:

  • Decrease in the Available Cash Amount:  When a company buyback its shares, it uses cash that is not in use for other purposes, such as investing in new projects or paying down debt. This can make the company more vulnerable to financial problems if it experiences a downturn.
  • Manipulated to Boost Earnings Per Share (EPS): If a company buyback its shares when the stock price is low, it can artificially boost EPS. This can make the company’s stock more attractive to investors, but it does not necessarily reflect the company’s underlying financial strength.
  • Can be Challenging for Shareholders: If a company buys back its shares at a premium to the current market price, it is essentially giving shareholders less money for their shares. This can be a risky proposition for shareholders, especially if the share price declines in the future.

Now that we have explored the advantages and disadvantages of buy back of shares, let’s do a comparative analysis of buyback of shares vs stock issuance.

Buyback of Shares vs.Stock Issuance

Buyback of shares meaning is to repurchase your company’s shares while the stock issuance refers to the company issuing and selling new shares to investors or the public. Thus, the main difference between a buyback of shares and stock issuance is that a buyback reduces the number of outstanding shares, while stock issuance increases the number of outstanding shares. 

However, let’s have a look at the stark differences between the stock buyback vs stock issuance.

AspectBuyback of SharesStock Issuance
PurposeCompany repurchases its sharesCompany issues new shares
Effect on SharesReduces the number of sharesIncreases the number of shares
Ownership ImpactDecreases outstanding sharesDilutes existing shareholders
FinancingUses the company’s cash reservesRaises capital for the company
MotivationTo support the stock price, signal confidence, and optimize capital structureTo raise funds for expansion, acquisitions, or investment projects
Impact on Earnings per ShareIncreases EPS as shares outstanding decreaseDecreases EPS as shares outstanding increase
Influence on PriceMay positively impact the stock priceMay negatively impact the stock price if the issuance is excessive
TimingDone when the company believes its stock is undervaluedUsually done when the company needs capital
Shareholder BenefitProvides liquidity to shareholders looking to sellOffers an opportunity for new investors to participate
Regulatory ConsiderationSubject to buyback rules and regulationsSubject to issuance regulations and approvals

Buyback of Shares vs Dividends

Here is a comparative analysis of Dividends and Share Buyback:

Aspects of ComparisonDividendsShare Buyback
Distribution MethodPeriodic cash payments to shareholders.Company repurchases its own shares from the market.
Impact on OwnershipReduces ownership proportionally for all shareholders.Increases ownership percentage for remaining shareholders.
Tax ImplicationsTaxed as income for the recipient shareholders.Generally results in capital gains tax for shareholders upon selling shares.
Signal to InvestorsTypically viewed as a positive sign, indicating company profitability and stability.May signal that the company believes its shares are undervalued.
Financial HealthPlaces a continuous burden on company cash reserves.Utilizes excess cash, indicating confidence in the company’s financial health.
Earnings Per ShareDoes not directly impact earnings per share (EPS).Can boost EPS as the number of outstanding shares decreases.
Market ReactionGenerally expected, with limited impact on stock price.Often positively impacts stock price due to reduced supply of shares.
FlexibilityProvides regular income to shareholders.Offers flexibility in returning value to shareholders without a fixed schedule.
Decision InfluenceDecided by the board of directors and subject to shareholder approval.Determined by the company’s management and board, often without shareholder input.

Successful Share Buyback Example

We will now explore what is buyback of shares with example. Let’s assume that XYZ Ltd is a technology company that develops and sells software. The company has been profitable for several years and has a strong cash flow. In 2023, the company’s management decided to undertake a share buyback program. The company repurchased ₹1 crore worth of its shares over the year.

The share buyback program was successful for many reasons. First, it increased earnings per share (EPS). The company’s EPS increased by 10% in 2023, due in part to the share buyback program. Second, the share buyback program sent a positive signal to investors. Third, the share repurchase program helped to reduce the number of outstanding shares. This made the company more takeover-resistant.

Overall, the share buyback program was a success for XYZ Ltd. Here are some of the specific details of the share buyback program:

  • The program was announced in January 2023.
  • The company repurchased ₹1 crore worth of its shares over the year.
  • The share buyback was funded by the company’s cash flow.
  • The current share buyback program was completed in December 2023.

Tax on Share Buyback

Until 2012, investors/shareholders were taxed on profits (capital gains) when a company bought back its shares. Capital gain, calculated by subtracting the purchase price from the buyback proceeds, determined the taxable amount.

Previously, buyback companies paying dividends incurred Dividend Distribution Tax (DDT). However, with share buybacks, the tax burden shifted to shareholders as capital gains. Unlisted companies, capitalizing on lower tax rates for buybacks, preferred this method over dividends to distribute funds.

To counter tax avoidance, the government introduced section 115QA in 2013 for unlisted companies; later, in July 2019, it applied to offer listed companies engaging in share buybacks. Tax is imposed on buyback income/distributed income for both listed and unlisted companies.

Distributed Income equals the buyback consideration minus the amount received by the company for the issued shares. In open market buybacks, where purchase prices vary, tax is levied on the company based on the buyback price and the price at which it issued shares.

Investors’ gains from buybacks are tax-exempt under section 10(34A) of the I-T Act, 1961, to prevent double taxation. Despite this exemption, shareholders should be mindful of Section 14A implications.

Share Buyback in India

Tata Consultancy Services, Infosys, and Wipro are some of the most talked-about share repurchases in India. According to reports, TCS buyback announcement of ₹160 billion in 2017 while Infosys announced a buyback of ₹130 billion in the same year. However, Wipro became the third largest buyback in Indian corporate history with ₹110 billion in 2018. 
Talking about the upcoming buyback of shares, Larsen and Toubro Ltd. (L&T), a renowned engineering and construction giant, is gearing up to  launch its first share buyback offer in the company’s 85-year history. The company is set to tender offer buyback a special dividend on buyback of equity shares for fiscal year 2023-24.

As per reports, Larsen and Toubro Ltd. (L&T) is set to approve ₹10,000 crore share buyback plan of equity shares for the fiscal year 2023-24. 

What are the Steps to Execute a Buyback of Shares?

In India, buybacks need to be approved through a Special Resolution or a Board Resolution. A company must complete the buyback within one year from the approval date. Here is a step-by-step guide to understand the share buy back conditions: 

  • Board Approval: The board of directors of the company must approve the buyback plan. The plan must include the following details:
  1. The number of shares to be repurchased
  2. The price per share
  3. The method of repurchase
  4. The source of funds for the repurchase
  • Shareholder Approval: The buyback plan must be approved by shareholders at a general meeting.
  • Announcement of the Buyback: The company must announce the share buyback plan to the stock exchange and the public.
  • Repurchase of Shares: The company can repurchase shares in the open market or through a tender offer.
  • Payment to Shareholders: The company must pay the shareholders for the shares that are repurchased.
  • Completion of the buyback: The share buyback is complete once the company has repurchased all of the shares that it has authorized.

What are the Recent Trends and Statistics on Buyback of Shares?

The global market for share buybacks has been on the rise in recent years. In 2021, companies around the world repurchased a record $881.7 billion worth of their shares. Thus, the highest levels of buyback activity have been seen in the technology and healthcare industries. In 2021, technology companies repurchased $286.7 billion worth of their shares, while healthcare companies repurchased $183.4 billion worth of their shares.

What is the Impact of Share Buyback on a Company’s Value?

Share buybacks can significantly impact how investors assess a company’s value. When a company repurchases its own shares, it can either cancel them, reducing the total outstanding shares permanently, or keep them as treasury shares, excluding them from share counts. This affects crucial financial metrics.

For instance, companies and investors use earnings per share (EPS), a key metric, to calculate by dividing net profit by outstanding shares. By decreasing the number of outstanding shares, a company can boost its EPS, creating the perception of improved performance. The price-to-earnings ratio (P/E ratio), which compares stock price to EPS, is similarly influenced by these buybacks, influencing how investors evaluate a company’s relative valuation.

Share Buyback for a Company vs Share Buyback for an Individual Investor

Here is a table of comparison between what happens when a company buys back its shares vs when investors participate in share buyback:

Aspect of DifferenceCompany Share BuybackIndividual Investor Share Buyback
ObjectiveOften to signal confidence, boost stock prices, or utilize excess cash.Typically for portfolio adjustment, belief in undervalued stocks, or diversification.
Impact on Earnings per Share (EPS)Can enhance EPS by reducing total outstanding shares.May not significantly impact broader market perception or EPS.
Market InfluenceCompanies may have the resources to influence market perception.Individual investors may lack the resources for significant market impact.
MotivationEfficient capital allocation when shares are perceived as undervalued.Aligned with personal financial goals and risk tolerance.
ScaleCan involve substantial financial resources and influence.Actions are limited to individual investor’s portfolio scale.
TimingOften strategic, timed to take advantage of market conditions.Driven by individual investor’s assessment and timing preferences.
Regulatory ConsiderationsSubject to regulatory scrutiny and compliance.Governed by individual investor’s adherence to trading regulations.

To Wrap It Up…

In recent years, share buybacks have been a prevailing trend in the corporate world. Many companies, especially in the technology and financial sectors, have been actively engaging in buyback activities. Thus, investors should watch out for the BSE buyback stock list. However, novice investors can use the S&P 500 Buyback Index to find companies that have been actively repurchasing shares.

FAQs

1. What are Buybacks?

Buybacks are when a company buys back its shares from the market. This can increase earnings per share (EPS) and can be a way for companies to return capital to shareholders.

2. Are share buybacks the same as stock price?

No. A share buyback is when a company buys back its own shares from the market. The supply and demand of the share determines the stock price.

3. Who benefits from a stock buyback?

Shareholders, management, and the whole company benefited from the stock buyback. However, it also depends on the circumstances that led to the share repurchase.

4. Is it good when a company buys back shares?

Share buybacks are beneficial for companies that do not need to fund expansions or other projects or wish to influence their stock price.

5. Why do companies repurchase shares of their share buybacks?

Share repurchase programs are primarily designed to achieve higher share prices. In this case, the board may feel that the company’s shares are undervalued, making it a good time to buy.

6. What is share buyback process?

You may engage in share repurchase, a corporate move where a company retrieves its shares from shareholders, typically at a price exceeding the current market value.

7. Why do shares fall after buyback?

Since the company expends cash to acquire shares, investors adjust their valuations to account for the reduced cash and shares, nullifying any impact on earnings per share.

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