Many of times we make ourselves busy monitoring our own portfolio and try not to think other than that and why not, we have invested our hard earned money and we expect maximum out of it. But meanwhile, we miss some of the very rare opportunities that give investors a chance to make a quick buck. I have so many examples but as of now, I will discuss a very important topic that every investor on earth should know about and that is Share Buyback.
A buyback is a process by which a company repurchases a certain amount of its outstanding shares from the shareholders. It is often known as stock repurchase that offers a way for companies to return some wealth to their shareholders, while potentially boosting their stock prices. Your portfolio will benefit from understanding exactly what lies behind a particular company’s decision to do so. Let's get started.
What is Share Buyback?
Stock buyback happens when a company purchases its own stock, either on the open market, or directly from its shareholders; it's known as a "share buyback", or "stock repurchase". Typically, companies that have excess cash in their kitty, with no specific investment or other deployment requirements for the same, may consider buybacks. Reducing the number of shares, in this case, helps in improving the earnings per share for continuing shareholders and perks up the return on equity.
Share buyback reduces the number of outstanding shares held by shareholders so,
EPS = Net Profit/number of outstanding shares
So less number of outstanding shares means better EPS.
What are the benefits of stock repurchase?
A stock repurchase plan can be a good way for a business to reinvest in itself, by using any excess cash at its disposal to buy back shares of its own stock. This is usually a welcome sign that a company is in a positive cash flow situation, and it often serves as a catalyst to
'Increase the company’s stock price at the same time, further increasing shareholder value'.
Explanation: Suppose you are the owner of a publically listed company ABC which is trading at 100Rs. you think that market condition dragged your stock price down which is way lesser than its actual value (intrinsic value). you announced that you will buy back the stock 130. everyone will rush to buy your stock at 100 so that sell you at 130 and that's how demand will increase and so the share price. So when share buyback is announced, stock prices tend to shoot up accordingly as investors rush to take advantage of the higher demand and lower supply situation. A stock repurchase can also help to bridge the gap between what a company’s shares are currently selling for, and what they theoretically should be selling for, in terms of the company’s book, or intrinsic value. When a company believes its stock is undervalued, buying some of it back from the marketplace will have the overall effect of raising its current selling price to one that is more in line with its inherent worth. Under the right circumstances, a stock buyback can be highly beneficial to you as a shareholder, since fewer outstanding shares in the marketplace automatically gives you a greater claim on a company’s earnings.
How can it be done?
By purchasing its own shares on the open market
By issuing a tender offer
By negotiating a private buyback
The most common stock buyback approach is through the open market. In this case, a company simply buys its own shares at the current market price, in much the same way that you would do as an individual investor. When a company presents a tender offer to its shareholders, on the other hand, it’s effectively offering to buy back some or all of its shares directly from them. A tender offer generally states the total number of shares the company is looking to repurchase, the price range it’s willing to pay per share, and the expiry date of the offer. Shareholders will be sent a letter of offer; a form is to be filled in with the necessary details and sent back to the company accompanied by the required documents. Promoters are allowed to tender their shares in this route. A stock repurchase of this type usually involves paying shareholders a share price that is significantly higher than the current market value. The final, and least common, way that a business can buy back its own shares is to negotiate their purchase privately, and directly, from a large individual shareholder.
Take an example of myself:
I personally had 150 shares of Infosys @950 and I participated in its recent buyback. got a mail from infy like this,
Infy agreed to buyback 42 stocks from me that made approx 25,000 Rs. profit within minutes. I sold rest of them @1147 some days back. You can participate too whenever a buyback offer comes in.
SEBI (the Securities and Exchange Board of India) has mandated a reservation of 15 percent of the buyback offer for retail investors with the holding of up to ₹2 lakh (market value as on record date).
Benefits for the company
1. Boost Undervalued Shares
2. Enhance Shareholder Value By Providing Cash Distribution
3. Increase Earnings Per Share (EPS)
4. Reduce Cash Outflow - Fewer outstanding shares mean fewer dividends to be paid, and a business often stands to save a significant amount of money when this difference far outweighs the cost to repurchase the shares.
Now you understand exactly why companies buy back stock and how this practice can help boost the stock prices and increase shareholders' value. So is it good when a company buys back stock? A stock buyback is meant to be a positive investor event that can help to increase the value of your shares. As a value investor, it can’t be stressed enough how important it is that you take the time to comb through the fine details of any share repurchase announcement for such warning signs as overvalued stock or an increased debt load, before acting on it. Like so many other investment events, share buybacks can turn out to be either a good thing or a bad thing for investors, depending on the circumstances. There are a number of situations where companies may choose to buy back their shares for all the wrong reasons. It’s important that you do your research and study a company’s financial reports in order to determine the true reason behind their decision to buy back shares. At the best of times, this decision will be based on a strong desire to promote shareholder value. But if a business is indiscriminately engaging in a share repurchase when their stock is overvalued, and they are using debt to do it, the end result is likely to be quite devastating for the shareholder. I hope you have definitely added something new to your knowledge bank today.
[Apologies for typo, if any]