Top 6 Reasons why Companies Go For a Share Buyback
A Buyback is a word which is trending on the Dalal Street at this moment. Why? The simple reason is that two major Indian companies, namely Larsen & Toubro Limited (LT) and Mphasis Limited have announced to repurchase (share buyback) its own shares from the market just a few days back.
Larsen & Toubro (LT) has approved a buyback proposal of 6 Crore shares, amounting to INR 9,000 Cr, at a price of INR 1,500 each. The number of shares makes up for 4.9% of total paid-up equity share capital.
Larsen & Toubro is one of the VALUEPICK of FINBLAB and has delivered more than 15% returns in one year
While the board of directors of Mphasis has approved a proposal for buyback of equity shares at a maximum price of INR 1,350 per equity share, amounting to INR 988.27 Cr.
Early this year, HCL Technologies Limited has announced a Rs. 40 billion buyback plan, involving up to 36.3 million shares at a price of INR 1,100 per equity share and the largest software exporter TCS also announced a Rs. 160 billion share buyback plan.
So, the question here is what is share buyback? And why do companies go for share buyback? Let’s understand this –
What Is A Share Buyback?
- There is no definition given by the Company Act, 1956 about the buyback of shares. But in simple words, a buyback share means repurchase of its own shares by the company. In other words, a buyback of share means a Company buying its own shares.
- A buyback is exactly reverse of the issue of new shares by a company where it offers to take back its shares owned by the investors at a predetermined price; this offer can be mandatory or optional to the investors.
Why Do Companies Buyback Shares?
Companies typically have two uses for profits.
Firstly, some part of the profits can be distributed to shareholders in the form of (1) dividends and (2) stock repurchases.
The remaining amount, known as retained earnings, are kept with the company itself and used for investing purpose in the future of the company if profitable schemes for reinvestment of retained earnings can be identified.
To Increase Promoter’s Shareholding:
When a company buys back its own shares, it reduces the number of shares held by the general public and at the same time increases promoter’s holding in the company. The reduction of the publicly traded shares also means that even if the profits of the company remain the same, the earnings per share (EPS) increase. So it’s like a dual advantage.
To Take Advantage of Undervaluation:
Apart from disbursing free cash flow, share buyback may also be used to signal or/and take advantage of undervaluation.
If a company’s management believes that their firm’s share is currently trading below its fundamental value, they may think about share repurchases – an open market buyback, whereby no premium is paid over current market value, offers a possibly profitable investment for the company manager.
By doing this, they repurchase the currently undervalued shares of the company, wait for the market to turn to the undervaluation whereby prices escalation to the fundamental value of the equity, and re-issue them at a profit.
To Prevent Takeover:
Share buyback evades the accumulation of excessive amounts of cash in the company.
Companies with strong cash flow generation and minimal capital expenditure will tend to generate more cash on the balance sheet, which makes the company an attractive target for a takeover since the money can be utilized to square off the obligation brought about to carry out the acquisition.
Hostile-takeover policies, therefore, often includes keeping a thin cash position and share buyback boost the stock price, making a takeover more expensive.
To Pump Up The Stock Price:
At times when the company feels that its shares are currently undervalued, a share buyback offer is used to inflate the stock price, which acts like a support for the stock.
There could be an end number of reasons why share prices of a particular company are trading lower despite solid fundamentals.
A buyback, on the other hand, reassures investors that the company has confidence in itself and is dedicated working towards creating value for its shareholders.
To Take Tax Advantage:
Share buyback allows companies to distribute their earnings to the investors without inflicting them with taxation.
To Reward Its Shareholders:
Another common reason for companies to go for a share buyback is to distribute surplus cash to its shareholders because the proposed offer is usually more than the current price.
This is normal practice when the share prices of the company keep falling and there is absolute nervousness among the shareholders either about the sector as a whole or the business itself.
Also Read –
1) Finblab’s Valuepick Stock for the month of August 2018 – Meghmani Organics Ltd
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