Have you ever heard about a buyback of shares by a company? If yes, then have you ever wondered, what can be the reasons for buyback of shares? With the increasing popularity of this concept, it is important to know why a company gets involved in the entire process and what are the motives.
In this article, we will talk all about it. So, let’s begin.
Before diving into the entire discussion of the reasons associated with the buyback of shares, it is important to know what does it mean. As the word buyback implies, it is when a company buys its own shares back at a higher price.
This is also known as the repurchase of the shares. The company can either purchase the shares directly from the open market or through a tender. In a tender, the company sets to sell the shares at a fixed price and on a fixed price and a fixed date.
The concept of buyback of shares is comparatively new in India, but over the years it has been gaining popularity. Many big names like Tata Consultancy Services, Emami Limited, etc have added their name to the list of buyback of shares.
Since many companies are involved in the procedure of buyback of shares, what are the reasons for it?
Let us have a look at the same.
Why Buyback Of Shares?
Once a company is listed on the stock exchange, its whole purpose is to raise capital through equity shares. But repurchasing the shares of their own company is giving back the same money that they collected. Although a lot of investors now claim that there are a lot of advantages of buyback of shares, the question still remains, what is the reason behind a company’s motive to repurchase the shares of their own company?
1. To Consolidate The Company’s Ownership
When an individual purchases the shares of a particular company, they are also entitled to part ownership of the company. Obviously, some of them also receive the company’s voting rights. Now, when there are too many owners of a company, it often becomes impossible to reach a unanimous decision.
Apart from this, it is often very tricky to manage the entire needs of all the shareholders. The company also has to give benefits to all the owners and sometimes it is like giving the benefits to the people who have in no term added to the decisions of the company.
So, when a company decides to repurchase its own shares, it is reducing the number of shares in the market and hence the ownership. It helps the company to take a certain hold on the company and also makes the decision-making and the management of the shareholders easier.
2.To Manage Extra Cash
If a company is performing well and is making great profits then it is obvious that they have surplus cash. Now there can be times when there is no new project to invest in. So buyback of shares becomes an appropriate way for a company to invest surplus cash.
It is always better than pilling up all the cash or keeping it in the safe. And what’s better than investing in their own business. This also gives the investors a sense of confidence that if a company is buying back its own shares, the growth potential must be great.
In addition to this, having surplus cash and no investments can also negatively impact the company’s reputation. So, the buybacks become good opportunities in these cases. This is one of the major reasons for the well-reputed companies to roll out a buyback of shares.
3. To Improve the Valuation of a Company
A company can often opt for a buyback if it thinks that the shares in the open market right now are undervalued. So, a company often chooses a buyback when they want to send this message or signal across. This raises a talk amongst the investors and brings the company to the forefront.
The undervalued companies signal that they have the potential to grow in the future and that it is the right time to invest in it. This works best for the shares that have seen an unexpected downfall even with strong fundamentals.
4. To Reward the Shareholders
When a company is making consistent profits, they make the shareholders a part of it by issuing dividends. But the dividends aid by the companies are taxed multiple times making it an expensive deal. While on the other hand, the buyback is only taxed once. In this way, the shareholders are getting the benefit and reduce the taxes as well.
Buybacks are also a good way to protect the prices of stocks even during an economic crisis like a recession. Imagine in a situation of recession where the company has to pay dividends to the investor. It is obvious that in these cases the company will be forced to cut down on the dividends, which might cause some of the investors to sell off their shares in the company.
Instead of this, if the company buybacks some of its shares at a higher price from its shareholders and then pay them dividends, it will not affect the share prices much.
Therefore, buybacks are a tax-effective and good option for companies to protect their share prices and the company even in the hard times.
5. To Improve The Fundamental Health
Many of the companies buyback their shares to improve their overall fundamental ratios. In the entire procedure of buyback, the aim is to reduce the number of outstanding shares in the market. The reduction of number of shares in the market results in the increase in the EPS(earnings per share) of the company.
This creates an overall good impact on the financial statement of the company. It also affects other fundamental ratios and gives a good boost to the company.
If the company is generally fundamentally strong, buybacks can give it a further push and create a good opportunity for the investors as well.
There are various reasons for the buyback of shares, but one thing that remains constant is that the prime focus of the company is to increase the overall financial health of the company and to make a better investments. It is sure that as more companies are now relying on the buyback of shares, it will gain more popularity in the near future. So, if you want to be a part of it, you can easily apply for buyback of shares of the concerned company and get the benefits.
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