Stock buyback is a transaction whereby a company repurchase its own share from market at a fixed price. This facility allow a company to go back to the shareholders and make an offer to purchase shares from them.
Generally we have two popular ways through which a company can return cash to its shareholders-
- Declaration of dividend or
- through buy back of shares.
Both methods are governed by a process laid down by law.
Due to stock buyback process, the number of outstanding shares reduces resulting higher earning per share (EPS) and return on equity for shareholders. Stock buyback is also known as share repurchase.
In India, buy-back of securities is governed by various sections of companies act 2013 and Companies (Share Capital and Debentures) Rules, 2014. In case of a listed company, the SEBI Regulations for Buy Back will also be applicable.
Stock buyback is not mandatory for the company. If management decided to go for repurcahse then they can do so by following the legal process. Here are a few steps that are generally followed to understand the concept of buying back of shares;
- Company’s board proposes repurchase of shares.
- The proposal is accepted by majority shareholders.
- Company announces stock buyback indicating price per share and number of shares it wished to repurchase from shareholders.
- Forms sent to all shareholders based on the percentage of their holdings and eligibility.
- Investors need to fill up the form that company sent to them indicating the number of shares that they wish to offer in the repurchase option.
- Company based on the applications received, accept the offer of repurchase.
Two ratios you have to remember in stock buyback: entitlement ratio and acceptance ratio.
If shares offered by you is in excess of the acceptance ratio, then the excess number of share will be returned back to your account.
Acceptance ratio is determined after the repurchase window closes based on the number of shares participated in the buyback process and number of shares tendered.
Benefits of stock buyback
Here are certain benefits;
- As share repurchase reduces assets and share capital of the company, due to which return on assets, return on equity and other metrics improve compared to not repurchasing shares.
- Earnings per share, revenue and cash flow per share also grow up more quickly because of less number of outstanding shares.
- After share repurchase, each shareholder will receive larger amount of dividend.
- It’s a reward to shareholders when stock of a competitor is performing better compared to its own shares.
- To control the drop in the share price by reducing the supply of stocks in the market.
- Due to higher EPS, value of company’s remaining shares goes up as the demand increase
It’s not that all stock buyback are good for investors. You need to analyze to have a better understanding of the company’s fundamentals before investing or to remain invested. For instance, a company might choose the repurchase root because it does not have any other profitable opportunities at present for growth.
Now you know what is stock buyback and whether its good for you nor not. For us, the answer to the question “is stock buyback a good thing for investors?” is simple, it depends.
