The Points to Consider When a Company goes for Share Buyback

A share buyback or repurchase implies that a publicly traded company is purchasing its own shares which it once issued from the investors. Usually, the company buys shares with the upper price than the price the share currently trades on any specific date. In this column we will discuss what share buyback or share repurchase is and the points to consider when a company goes for share buyback.

What is Share or Equity

Friends, before we get into this, let’s discuss what the share or equity is and how it works. Stock or equity is an ownership right that a company gives to whom the company issues preferential shares. It may seem awkward that you become the owner of that specific company by purchasing the shares of the company. The company has many equity shareholders. All these shareholders or owners then become eligible for any profit made by the company according to their investments. As they are the equity holders, they have the voting right in any issues related to the company either it is for receiving debt from the market or the business expansion.

The Points to consider when a company goes for Share Buyback

When a company earns or has large ideal money then it tries to manage the huge money in the purpose of share buyback. When a company needs money then it offers equity shares or ownership rights to any individual or any other organisation in accordance with the money the concerned individual or the organisation invests in that specific company. On the other hand, share buyback is opposite to that. Share buyback is when a company gives money to its shareholders for selling the shares to that specific company. In this way share buyback enables an investor or equity holder to earn cash money by selling his stake in the company.

Usually, in a share Buyback policy a Company offers a higher price for the specific stock. Let’s make it clear with an example. Suppose, Infosys announces share buy back up to a limit of Rs. 1000 and on any specific date the stock trades at Rs. 100/-. The company offers Rs. 120/- to buy a share on that specific date. So, the investors can gain a 20% return. Many investors sell the stock to the company at that price. This is share buyback. Generally, short term investors or new investors in any stock sell their stakes or shares to that company which offers share buyback at higher prices. The share buyback enables a company to reduce the total outstanding shares in the market and reduce the number of share holders. This eventually affects an increase in dividend yield and better control over the company.

So, as an individual investor what you will do remains important when a company offers the share buyback on any stocks in which an individual has invested. You need to consider the following points while any company offers share buyback.

Watch out the Fundamental, Qualitative aspects of the company

If you find the fundamental aspects such as Debt ratio, compounded sales growth, compounded profit growth, return on equity, dividend payout, etc. and Qualitative aspects such as business model, competitive advantage, management of the company are quite good then do not get trapped into the buyback policy of the company. If the profit and loss account, balance sheet are quite impressive and the company has delivered robust performance year-on-year basis don’t make the mistake to sell the stock in the sake of 20% return.

Effect on Dividend Yield

Many retail investors get confused between the relation of Share buyback and dividend yield. Dividend is paid by a company to its shareholders in accordance with profit margin or operating profit. So, when the profit margin increases year on year then the dividend yield increases accordingly which enables investors to create another passive source of income. So, before exit from any company in which share buyback is offered, you need to check whether the company is giving the regular healthy dividend payment. If the answer is positive then you need to stay invested in that company. Since share buyback enables the decrease in outstanding shares and equity holders, there is a possibility of increase in dividend payout.

Make use of Ideal Money

When the company has significant amount of surplus cash or ideal money and they have no plan how to utilize the large cash, they try to manage the huge money in share buyback to reduce the outstanding shares and increase earnings per share.

Final Thoughts

To conclude share buyback policy is useful for retail investors also in the sense that share buyback enables a win-win situation for the company and retail investors both. Since the companies have to pay a dividend distribution tax @15%, and an investor has to pay taxes on dividend, it is a better choice for a company to buy back its own shares than to pay dividends which attract taxes for both.

Apart from this, there is another reason for share buyback. Share buyback enables a company to reduce its outstanding share. So, the earning per share will increase accordingly. The remaining shareholders obviously gain more earning per share. When a company’s management is quite efficient enough and able to deliver the robust performance in the near future it usually offers share buyback scheme to retail investors. This enables the company to gain a consistent return on equity for the promoters of the company. When any company offers share buyback then it can be easily concluded that the promoters of the company are quite confident about the performance of the management of the company which will enable better returns and regular dividend yield in near future.

If you have any doubt regarding share buyback feel free to make a comment section so that we have a discussion. If you have found this post helpful please share with your loved ones.

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