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What is Share Buyback/Repurchase?
Share or stock buyback is the practice where companies decide to purchase their own share from their existing shareholders either through a tender offer or through an open market. In such a situation, the price of concerning shares is higher than the prevailing market price.
When companies decide to opt for the open market mechanism to repurchase shares, they can do so through the secondary market. On the other hand, those who choose the tender offer can avail the same by submitting or tendering a portion of their shares within a given period. Alternatively, it can be looked at as a means to reward existing shareholders other than offering timely dividends.
However, company owners may have several reasons for repurchasing their stocks. Individuals should make a point to find out the underlying causes to make the most of such decisions and also to benefit from them accordingly.
Reasons for Share Buyback?
There may be several reasons why a company opts for a stock buyback. However, the list below highlights the most common reasons for the same.
When There Is Excess Cash But Not Enough Projects To Invest In companies issue shares to raise equity capital and expand their venture, but often such a practice does not prove to be of much use. Similarly, keeping excess money at the bank is more like a truncated cash flow offering liquidity over the ideal requirement. Hence, instead of piling on cash reserves, companies with robust financial standing tend to make the best possible use of the cash available through a stock buyback.
It is a Tax-effective Rewarding Option when compared to dividends, share buybacks are more tax-effective for both companies and their shareholders. To elaborate, stock buybacks are subjected only to DDT, and the amount of money is deducted before distributing the earnings to the surrendering shareholders. On the other hand, dividends are taxed at 3 different levels.
To Consolidate Hold Over the Company often when the number of shareholders of a company exceeds the manageable limit, it becomes challenging for the entity to reach a decision unanimously. Additionally, it may result in a power struggle within the company and among the shareholders with voting rights. To avoid or aggravate such situations, company board members often resort to share buybacks and plan to consolidate their hold over the company by increasing their voting rights.
Impact of Share Buyback
The following pointers highlight what are buybacks impacts that are faced by a company’s different financial aspects.
Effect on Earnings Per Share (EPS)
Repurchasing a company’s shares lays a direct impact on its EPS by increasing the ratio significantly. It mainly happens because the net income tends to remain the same, while the total number of outstanding shares reduces post repurchasing.
Effect on Financial Statement
The money spent to repurchase company stocks would be recorded in the business’s earnings report and can also be found in the statement of cash flow under the head ‘financial activities as well as the statement of retained earnings.
Besides influencing the income statement of a company, the impact of share buybacks can be noticed in other financial statements as well.
Effect on the Company’s Portfolio
Usually, companies who have faith in their prospects indulge in the practice of repurchasing their company shares. Such a display of confidence is received positively by potential investors and existing shareholders and helps earn their trust significantly. In turn, it helps the company to enhance its market reputation and facilitates an increase in its share value naturally. All of this directly helps improve the venture’s portfolio significantly.
Effect on Increasing Shareholder Value
Business owners who opt for share repurchase are more likely to enhance their EPS significantly, and that too much faster than operational improvements. Investors scouting for profitable investment options tend to acknowledge companies with steady EPS as a better income-generating avenue with enhanced growth potential.
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