Explained: What is share buyback and why do companies go for it?

Share buyback is a corporate action in which the company buys back the shares from its existing shareholders either via a tender offer route or through the open market offer under Section 68 of the Companies Act 1968. The buyback of shares is out of companies' free reserves or the securities premium account.

why do companies buy back shares, and how is it useful to investors? image- Pexels

The earnings season is underway, and along with their financial results, many companies have announced plans to buyback or repurchase their shares. Piramal Enterprises, Larsen and Toubro (L&T), Amrutanjan Healthcare, Aarti Drugs, and IndiaMart Intermesh are some of the names that have announced share buybacks.

A share buyback is a corporate action in which the company buys back the shares from its existing shareholders either via a tender offer route or through the open market offer under Section 68 of the Companies Act 1968. The buyback of shares is out of companies' free reserves or the securities premium account.

But why do companies buy back shares, and how is it useful to investors? Let's understand them one by one. But first, a little more detail on share buybacks.

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Share buyback, or share repurchase, is when a company purchases its share to reduce its outstanding share in the market. Often, in a buyback offer, the shares are bought by the company at a price higher than the prevailing market price.

So why do companies opt for buybacks of shares?

A company can repurchase its stock for numerous reasons, including:

-to boost the value of the stock;

-when they have cash on hand and the stock market is on an upswing;

-when there is excess cash but not enough projects to invest in;

-to consolidate its hold over the company.

-to signal that the stock is undervalued.

"There are several possible reasons for a company to repurchase its shares, including regaining ownership, returning excess cash, optimising its capital structure, and reducing the number of outstanding shares in the market, which results in reducing the cost of capital," said Palka Arora Chopra, Director, Master Capital Services Ltd.

How does a share buyback impact investors?

According to Ravi Singhal, CEO, GCL Broking, companies can increase shareholder value through share repurchases. The portion of income that a company spends to repurchase shares has a favourable impact on the share price in normal market circumstances.

For instance, a shareholder holds 100 (or 10 per cent) of the 1,000 shares in a listed corporation. Through a share buyback scheme, the corporation buys back 100 shares, bringing the total number of shares down to 900. The stake of that shareholder will increase by 1.11 per cent to 11.11 per cent, entitling them to a larger portion of the earnings.

According to Amar Ranu, Head, Investment Products & Insights, Anand Rathi Shares, and Stock Brokers, share buyback is also an alternative way to reward shareholders relative to dividends. Unlike dividends, where the taxation is at the shareholder level (at higher levels of income, the tax is higher), in share buybacks, the company pays the applicable tax, which is 20 per cent.

What are the share buyback methods?

Open market offer

Through this method, the company repurchases the shares from sellers directly via the stock exchange. This is usually done through brokers. The shares purchased via this method are usually bought at the current market price.