Why companies go for share buybacks?
Team Veye | 30-Dec-2019
A stock buyback, also known as a share repurchase, occurs when a company buys back its shares from the marketplace with its accumulated cash. The repurchased shares are absorbed by the company, and the number of outstanding shares on the market is reduced.
Share buyback is basically a corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than market price. Buybacks increase the proportion of shares a company owns. A buyback allows companies to invest in them.
A company can ask shareholders to return a percentage of their shares voluntarily to the company. Investors then decide how much of their shares they are willing to sell at the price range given by the company.
Another way a stock buyback can be executed is by open market trading. In this the company buys its shares from the market, just like other investors would, by paying market price for each share.
But why companies indulge in it. And how does it impact the portfolio.
There are many good reasons that companies want to pursue buybacks. A stock buyback can allow a company to reduce its cash outflows without having to reduce the amount of dividend paid to investors as the investors hold fewer shares now. The company can then preserve capital after completing buyback.
Buying back shares is also a way to counter the potential undervaluing of the company’s stock. The company can send a positive signal by investing its capital in buying back shares. It can thus, restore confidence in the stock which in turn can push the stock higher.
Buybacks also reduce the amount of assets on a company’s balance sheet. It can increase both returns on equity and return on assets. A buyback can also result in higher earnings per share ratio. That gives another positive signal to the market.
The primary advantage of buyback programs is that an investor's shares become more valuable and represent a greater percentage of equity in the company. In the near term, the stock price may rise because shareholders know that a buyback will immediately boost earnings per share.
For businesses, stock buyback programs help replace equity financing with debt financing, which is often more cost-efficient.
Share buybacks are not always appreciated. While they can make most investors happy, a few will question why profits are being spent to boost shareholder value instead of being invested back into the company. A much lesser relevant point could be the lack of growth opportunities while having a lot of cash on the books. Such cash rich companies go for buyback as an option.
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