What Is a Buyback?
To make a smaller number of shares accessible to the open market, a company usually buys its shares. This is known as a share repurchase, which is also commonly known as Buyback. A company does so for many reasons. By buying its shares and minimizing the supply, it may increase the worth of the remaining shares. It may also curb the shareholders opting for a controlling stake.
- A company buying its outstanding shares in the stock market is termed as a Buyback.
- When a company repurchases its shares, it increases profit per share and increases the worth of the stock.
- The companies repurchasing their shares tell the investors that they have a required amount of cash kept separately in case of emergencies and that their probability of facing any economic issue is low.
When a company opts for Buyback, it allows them to invest in themselves. When they do so, they reduce the number of outstanding shares available in the open market, which increases the number of shares owned by the investors. Doing a buyback lets company provide a good return to the investors when they feel that their shares are not valued much. Opting Buyback also increases the earning of a company. This will hence elevate the price of the stock when a constant P/E ratio is maintained.
The amount of shares reduces during a share repurchase which makes each amount valuable for any corporation. When the P/E ratio or the price to earnings ratio decreases, the EPS or the earnings per share increases. When it does a buyback, the company tells the investors that they have enough money in case of any emergencies and that they have a very low chance of facing any economic troubles. When a company chooses to repurchase, they offer their staff and employees stock options and stock rewards. For this, companies buy its shares and can give their employees compensation purposes. The two ways in which Buybacks can be carried out:
1. The shareholders are given the option to offer a part of their shares at a healthy price to the present market price in a given time interval. This good pricing of shares allows the investors to not hold on to and offer their shares.
2. The companies also draft a program for share repurchasing in which shares are being purchased at regular intervals.
Companies can also fund their Buyback with the cash they have in hand or by accepting debts. An expanded share buyback boosts a company’s plan to repurchase the existing share, and its magnitude decides the impact on the market. This expanded share buyback also increases the share price. The buyback ratio gives the buyback dollars which were exhausted in the previous year. The buyback ratio also tells us the company’s ability to offer good returns to its shareholders as most companies are involved in regular buying back of shares and have surpassed the market.
Example of a Buyback
A great example is that of a company which performed well as reflected in the previous year’s financials but underperformed. In order to reward investors, a buyback program can be undertaken by a company of around 10% at the current share price. For example, Company had Rs.1000 in earnings and 100 shares before any buyback, making earnings per share Rs.10. The P/E ratio comes out to be 20 for Rs.200. Out of 100 shares, 50 have been repurchased, which makes earning per share Rs.20. To maintain P/E 20, the share price would be Rs.400.
Criticism of Buybacks
The issue with a share buyback is that investors feel that the organization is not having other opportunities for profit and growth. Tapping into Buyback becomes an issue for the growth investors who are on the lookout for profit. So an organization doesn’t need to repurchase its shares during market changes. If the economy is going through a downward trend or an organization has a financial crunch that is difficult to recover, Buyback puts the organization at an uncertain stage. Other allegations are that buybacks can artificially inflate share price in the market, resulting in high bonuses for higher executives. There are some frequently asked questions on buybacks. Let’s have a look:
Why do Companies undertake Buybacks?
Buyback is a method for companies to invest within themselves. It can give higher returns to investors if the company thinks that its shares are undervalued. The volume of shares present in the market gets reduced due to Buyback, making the price of shares higher as the company market is distributed in lesser shares. Compensation purposes is another reason. The buyback shares are given to management and employees as stock options or stock rewards, and it doesn’t dilute the shareholders already present. It might also prevent the existing shareholders from taking a major stake.
In what way is a Buyback conducted?
An offer at a healthy price over the existing share price is made to the shareholders by the company. Shareholders have to either hand over all the shares or a part of them within a given period. A program is also kept by the company for a longer period, like a repurchase share program doing the respective trades at various times. The fund for Buyback can be arranged by available in-hand cash or operations cash flow or by taking a loan of some sort.
What Are Nit-pickings of Buybacks?
The issue with a share buyback is that investors feel that the organization is not having other opportunities for profit and growth. Tapping into Buyback becomes an issue for the growth investors who are on the lookout for profit. So an organization doesn’t need to repurchase its shares during market changes. If the economy is going through a downward trend or an organization has a financial crunch that is difficult to recover, Buyback puts the organization at an uncertain stage. Other allegations are that buybacks can artificially inflate share price in the market, resulting in high bonuses for higher executives.