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Highlights
- Share buyback is considered as a method to return money to shareholders.
- The buying back of shares boosts up investors’ confidence.
- There are two methods of share buyback -- Tender offer buyback and Open market buyback.
To get returns, we invest in the stock market. With returns, the stock market also provides additional advantages. For example, when the company announces a dividend, but other than dividends, there are also share buybacks. So, what is it? How do share buybacks impact? Here we will discuss essential aspects of share buyback.
What is a share buyback?
It is a corporate action in which companies buy their shares from the shareholders. Repurchasing happens when a company reacquires its stock in the open market using cash.
It is considered as a method to return money to shareholders. The share buyback process is a tax-efficient method to return cash to the shareholders.
The buyback is different from dividends as it does not provide an additional profit to shareholders apart from the current share price. When a company buys back shares, the leftover shares become more valuable.
Also read: Share Buybacks and Dividends still under Fed leash: Extends Restrictions
Why do companies buy back their own shares?
There are various reasons, but the main reason is because the company’s management feels that its current market price is undervalued or its shares’ market price is lesser than its real value, so to increase or boost demand, the company does a buyback. The buying back of shares also generally boosts investor confidence and increases the ownership value of the shareholders.
Also read: 5 Canadian dividend stocks to buy in 2022
Impact of share buyback
It affects the company’s EPS (earnings per share) as when the company does a buyback its EPS and share value increases as the number of shares decreases.
EPS can be calculated by the net profit divided by total outstanding shares. For example, before the buyback, the company’s net profit is C$ 10 million and the total number of outstanding shares is two million, then the EPS is C$ 5.
After the buyback, if a company repurchases 200,000 shares, then the company will be left with 1.8 million shares. Now the EPS will be around C$5.56. So, the EPS has increased.
How does a share buyback work?
There are two methods of share buybacks -- tender offer buyback and open market buyback.
Tender offer buyback
In this method, the company brings a tender offer to the shareholders in which they can provide a part of their shares within a given time. The offer depicts at what price the company will buy back its shares.
The tender offer buyback allows the company to buy their shares from investors at a higher price than the market value.
Open market buyback
In this process, the company can buy its shares from exchange platforms. It usually announces how many shares it will buy in a given time.
Also read: What is market capitalization & how it can help investors?
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Advantages of share buyback
The buyback program is more flexible in terms of time, compared to paying dividends. The company may terminate the repurchase program and make changes according to requirements. The shareholders are also not under pressure to sell their shares, they can keep them if they want.
Disadvantages of share buyback
The repurchasing process can motivate unethical investors to use the company’s money to enhance their ownership. It also allows for some control over the share price despite no true growth in the company’s financials.
Also read: Is StockX going public & can you buy its shares?
Bottom line
A buyback can boost a company's EPS and can increase the value of shareholders. It can also impact the company and its investors given the reduction in the total no of outstanding shares.
