Buyback shares: Reasons, advantages and disadvantages

Meaning of Buyback of Shares

Buying shares is a financial engineering tool. It can be defined as a process allowing a company to return to its shareholders and offer to buy the shares they own.

Buyback helps an organization make better use of its funds than by reinvesting those funds at a lower average rate into the same company or by needless divergence or purchasing growth through expensive acquisitions.

Also Read: Issue of Bonus Shares to the Shareholders

Reasons for Buyback

There are reasons why a company would opt for the buyback

1. To boost shareholder value, buying back offers a way of using the surplus funds of companies with unattractive alternative capital options. A reduction in the capital base resulting from buying back will typically produce higher earnings per share (EPS).

2. It is used as a defensive mechanism in an environment in which the threat of company takeovers is real. Buy-back offers insurance from a hostile takeover by increasing the assets of promoters.

3. It will encourage businesses to reduce their equity base, injecting much-needed flexibility.

4. The intrinsic value of the shares is increased by a reduced floating stock ratio.

5. It would allow businesses to use buyback stock, without expanding their capital base, for subsequent utilization in the process of mergers and acquisitions.

6. Share buying is used as a financial engineering tool.

7. It is used to report the impact of buyback on the share price

Financing Aspects of Buyback

Finance is the central hub of business, and success depends more on improved and effective fund and finance management. The company requires vast capital and money, mobilized from one or more sources to buy back shares and securities in large numbers.

1. Internal sources

2. Sufficient cash position

3. Selling of temporary investment with the least possible loss

4. Raising of working capital needs

5. Raising cash by issuing fixed deposits

6. Raising by the issue of debentures and loan bonds

7. Cash credit from commercial banks

8. Overdraft from commercial banks etc.

Benefits

1. Companies that are below their average industry profitability enjoy better share price appreciation after purchasing shares than companies with profitability above their industry average.

2. Companies whose sales growth was below their industry average had a higher share price rise after the repurchase of shares than those whose sales growth was above their industry average.

3. Rentable and development businesses that repurchase shares are a direct indicator to investors of the company’s strengths.

4. Repurchasing businesses with lower debt ratios but sales growth rates above their average industry report significantly higher share price growth following repurchase than firms with above-average debt ratios but sales growth below their industry average.

5. Repurchasing companies with returns and debt ratios below their industry average display better share price growth after repurchasing than companies with income and debt ratios above their industry average.

Also Read: Share Transfer Procedure in Private Limited Company

Drawbacks

For the following reasons, the repurchase of shares is criticised:

1. This might encourage unscrupulous promoters to use the money of the company to increase their stakes.

2. It opens up opportunities to control share prices.

3. It could distract the funds of the organisation from productive investments.

Conclusion

A buyback, also known as a stock repurchase, happens when a business sells its outstanding stock to minimize the number of free-market stock. For various purposes, corporations are buying back shares, for instance, to raise the value of remaining shares by reducing the supply or stopping other shareholders from taking control of shares. The method of buying back shares involves direct deals with large individual shareholders, open market opportunities, fixed price bids and the Dutch auction deal. The main benefits of repurchasing shares are their versatility. Shareholders may or may not wish to sell back and the business may also approve or cancel repurchases. Other advantages are the tax incentives and signaling opportunities for businesses. Shareholders must verify that transactions are good and consider reasons for transactions in order to take an informed decision.