Why Some Companies Use Buyback Strategy?

By Advisorymandi
24-April-2018 12:24:47 PM
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Buyback Strategy

You must be familiar with the corporate strategy “Stock Buyback or Shares Buyback” which is the re-acquisition by a company of its own stock. This strategy allows companies to buy back their own shares by paying shareholders the market return and recollect its ownership that was once distributed among public and private investors. This is a  corporate strategy to invest in themselves by reducing the no. of shares outstanding on the market. It can be executed by either presented with a tender offer or buy back shares on the open market over an extended period of time.

But, the question is –

Why companies go for buy-back?

And What they gain from it?

Let’s find out one by one.

Reasons for Buy-back

Increase Financial Ratios & Confidence Level
Just imagine! If you own a company and buying back shares, what impression would it put on management? Well, It can be viewed by the management that you have enough confidence to build yourself again. On top of that, the market investors will see it as a sign of growth in the value of shares in the future.

In a statical way, the stock buyback strategy improves company’s earnings per share (EPS) and price to earnings ratio (P/E).

Undervaluation of Stock
It is one of the most common reasons for buying back the stock. Stocks can be undervalued for a lot of reasons which lead the issuing company to repurchase the shares at the reduced price and reissues the shares at the new market price after regaining popularity thereby increase in its equity capital of equity market. This is a way out to the shareholders when the stocks are undervalued.

Equity Funding
Usually, companies issue shares to raise equity capital to fund expansion but if the stocks have no future potential then there is no point of holding onto all unused equity funding at all. Plus, shareholders expect to get decent returns on their investments in the form of dividends. If by buying back some or all outstanding shares, it is possible to pay off investors and reduce the cost of capital then it is a good idea to use stock buyback strategy.

In short, you can say stock back buy is a corporate strategy which can prevent unwelcome takeover bids.

So, we can say that in such circumstances companies can implement the buyback strategy to buy outstanding shares for the benefit of the company. It is not a desperate move but more like a strategy to generate more equity capital without issuing any additional shares at all. Plus, when there are fewer outstanding shares the fewer people the company has to answer to.

Now that it has been cleared of why and how let’s find out what new rules are coming out for stock buyback so that you have complete knowledge of buying back outstanding shares in what circumstances.

What SEBI has New in Mind for Stock Buyback Rules?
The market regulators of Securities & Exchange Board of India (SEBI) is considering to come out with a new rule on stock buyback programme where the company will only able to repurchase shares with a maximum limit of 25 percent of the company’s paid-up capital and other reserves.

Also, the company can do this on a proportionate basis through the tender offer, odd-lot holders, and open market via – book building process and stock exchange etc. And in open markets, this will be only applicable when a buyback for 15 percent of the paid-up capital and free reserves of the company will be made.

Are there any flaws in it?
No doubt share buybacks increase some ratios like EPS, ROE, and many others but sometimes the increase in ratio doesn’t mean there is also increase in profitability and the main reason of increases on the ratio is due to a decrease in outstanding shares.

Another reason which makes stock buyback or shares repurchase not a good idea is overestimating the future prospects.

Final Thoughts: –
Overall, we can say that stock buyback is a great way to treat undervaluation of stock and increase return ratios and confidence level but at a certain point. And there is no 100 percent guarantee that it would be effective. In fact, some leading analysts think, “Buybacks are not that dependable way to predict future stock performance as it was back then.”

Maybe it is because of the huge popularity which it has gained in recent years. Nevertheless, you can decide to implement this corporate strategy as per the circumstances you are in. And if you would like to add something or have any query, then don’t forget to mention it in the comment section given below. We will be happy to hear from you.

 

Note: All information & data provided in this article is for the educational purpose as well as to give general information on the finance & economy, not to provide any professional advice or service. Views & opinions are not biased against the company and do not affect any official policy or any other agency, an organization within the content.

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Author: Advisorymandi

AdvisoryMandi is India's most trusted Stock Market Advisory marketplace covers NSE, BSE, MCX & NCDEX. Invest with confidence and harness the power of AdvisoryMandi to make smarter investment decisions in Stocks, Indices, Commodities, Forex & IPO.

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[…] to see the other motives of PC Jeweller who decided to buy back its own shares. But, whenever a company uses buyback strategy, it is for increasing financial ratios & confidence level, equity funding, and undervaluation […]

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