The companies listed in the stock market often hustle and make sure that the investors have all the chances to earn good profits and rewards. One popular way in which companies do this is by paying dividends to their shareholders. But as they are taxed thrice, a lot of companies now rely on buyback. But what exactly is the buyback of shares?
Let us have a look at the buyback of shares and how they work. So let’s begin!
Buyback of Shares Meaning
Buyback as the name implies is when the company repurchases the shares from its own shareholders and usually at a higher price. This is also called the repurchase of shares.
Now, there are various reasons why a company opts for a buyback, but the basic idea behind this is to enhance the valuation. It is a way in which a company invests in itself. Buyback of shares reduces the number of shares in the market and is often considered a tax-effective way of rewarding the shareholders.
Now a company can repurchase the shares in two ways: open market or through a tender request.
- Open Market
This is when the company buys the shares directly from the secondary market. In this case, the purchase is completed at the market price. This is one of the most common ways for a company and is very convenient.
- Tender Request
Another way to buy back is through a tender request. In this, the company sends out a tender form to its shareholders asking them to sell their shares. The offer has the complete details of the buyback. The investors can shed a portion of their shares and mention the price they are willing to get. After a company has received all the shares, they look for a suitable price and then purchase the shares.
So, the buyback of shares usually goes on for some days and it is during this period, an investor has to apply for the same. There is a record date associated with the buyback of shares. It serves as a deadline and implies that anyone who has had the shares of the company till that date is only eligible to sell their shares in the buyback.
For example, if the record date of a buyback is 3rd April, then any investor who has the shares of the company on or before that date are eligible for the buyback.
Buyback of shares has started gaining popularity with the newest addition of companies like TCS and GAIL. The shares are issued according to a ratio. If the ratio issued by the company is 10:1, then on every 10 shares that you own of the company, 1 share will be eligible for the buyback.
An investor gets the cash in their trading account after the acceptance of the request. Now, that we know the meaning of buyback of shares, let us discuss what can be the possible reasons for the buyback of shares.
If a company is thinking to repurchase its own shares from the secondary market, there have to be some reasons for the same. Let us have a look at some of the objectives behind the company’s idea of bringing the buyback of shares.
- Reduction in the number of shares- One of the major reasons for a company to go for a buyback is to reduce the number of shares in the market. This eventually increases the demand of the stock in the market, causing the investors to benefit from the same.
- Consolidate the company’s ownership – When you purchase a share of any company, you also get a part-ownership of the company with certain rights. During the time of making any decision or voting, it often gets very difficult to come to a unanimous decision because of a large number of people. When there is a decrease in the number of shares, it also consolidates the ownership and helps the company to come to conclusions easily. It also makes sure that the promoters are not losing out on a major chunk of their holdings.
- Improving the valuation of a company- Most of the time, the company opts for buyback of shares when they think that the company is undervalued presently. If a company repurchases its own shares at a higher price, it gives investors the trust that the company is likely to grow. This further helps the company in not only rectifying the valuation of the company but also to grab the attention of the investors.
- Boosting the Fundamental health- When the company is reducing the shares, it increases the company’s EPS (earnings per share). This further improves other fundamental ratios of the company as well. Therefore, the buyback of shares can actually improve the fundamental health of the company.
- A reward for the shareholders- Every investment that a shareholder does is with the intention to gain profits in the future. Buyback is a way of giving the money back to the shareholders as a reward for their trust and investment. Unlike dividends, there is no three-level tax on buybacks. So it is a better and tax-effective way for the company to reward the employees.
These are the major reasons why a company opts for the buyback of shares. But is there any value or benefit of the buyback of shares for the company or the investors? Let us have a look.
Share buybacks have various advantages associated with them, and the addition of big names in the game is a testimony to that. So let us have a look at the benefits of this entire procedure.
- The buyback of shares improves the valuation of a company. When a company thinks that the shares of its companies are undervalued, they choose the repurchase of shares. So, the whole process of buyback rectifies the value of the company.
- It also builds trust amongst the investors that the company has high growth potential and great future plans.
- Buybacks are a tax-effective way of rewarding the shareholders. Dividends are taxed thrice, unlike the buyback of shares. So it becomes a convenient option for the company.
- When the company announces a buyback, there is a sudden rise in the prices of the shares because of the increasing demand and limited supply. This opportunity can be very beneficial for some traders.
- The reduction in the number of shares in the market results in an increase in EPS (earnings per share). This leaves an overall positive impact on the reputation of the company.
Now, all these benefits make the buyback of shares an interesting opportunity.
Disadvantages of Buyback of Shares
The next question is, are there only benefits of a share buyback? The answer is no. There are some drawbacks as well that can hamper the whole idea and process of share buyback.
- One of the major drawbacks of repurchase of shares is that it can give false estimates of the valuation of the company. There can be chances where the company might miss a point or two in the correct valuation or the future prospects.
- The buyback of shares reduces the number of shares in the market and therefore causes a downfall in the supply. This suddenly increases the prices of the shares which can give a false illusion to the investors.
- A sudden increase in price also increases some fundamental ratios like EPS, ROE, etc. This can also generate false signals for investors and traders.
All these cons can often cause an investor to maintain a distance from the company opting for the buyback of their own shares.
Now that you know what is a buyback and what are the pros and cons of the same. The next thing to consider is, how can you apply for a share buyback. But before that, you should be aware, of whether or not you are eligible for applying. Some things that you have to keep in mind before applying for the buyback of shares.
- You should have the shares of that particular company on or before the record date.
- It is advisable to have at least the minimum number of shares in accordance with the entitlement ratio. For example, if the ratio is 5:1, this means that for every 5 shares that you own of that company, you will be eligible for the buyback of one share. It is therefore important that you have at least 5 shares of that company in your account.
But what is the process to sell shares in the buyback? Let us have a look at the steps that you have to follow to apply for the buyback of shares.
- Login to your trading app with your login credentials.
- On the dashboard click on the desired option. In Zerodha, you will see a tab named Corporate actions.
- Now you will see the shares of the company available for buyback.
- Fill out the tender request form issued by the company. The general details include DP ID, number of shares, etc.
- Some brokers also ask for a TPIN when you apply for the repurchase.
Once, you have filled and submitted the duly filled form, you just need to wait for the repurchase of the share.
Buyback of shares can help a company boost its valuation and help it reach certain goals. But this is only possible if the company accurately estimates its future and growth prospectus. It is a new concept but you can learn stock market and make the best of every situation.
Apart from this, you can get familiar with more stock market concepts through stock market courses. There are various courses available on the Stock Pathshala app. You can download it and start learning!
Before investing capital, invest your time in learning Stock Market.
Fill in the basic details below and a callback will be arranged for more information: