Buyback of Shares

When public companies profit significantly, they often pay back the excess earnings to shareholders by paying dividends. But another way for profitable firms to reward investors is a buyback of shares. Delve deeper to explore in detail the concept of share buybacks. 

The concept of a buyback of shares refers to companies buying their own stocks from the open market. Companies often do this to return money to shareholders. The money that companies return is usually an amount that they don't need for their operations or other investments. 

During a stock buyback, a company will invest in stock shares on the secondary market from all investors looking forward to selling. Shareholders are not obligated in any way to sell the stock back to the organization. Moreover, a share buyback will never target a specific group of shareholders. Instead, the process is available for everyone.

All public companies interested in a buyback will declare that the board of directors has authorized a repurchase. The repurchase authorization sheds light on the exact amount allocated for buying back the shares. At times, the repurchase authorization will specify the number or percentage of outstanding shares that it plans to buy back. 
 

The different reasons behind a buyback of shares are as follows:

●    Availability of excess cash but not enough projects to invest in: Organizations issue shares to get equity capital and diversify their venture. However, this practice does not prove to be useful in most cases. Meanwhile, keeping extra funds at the bank seems like a truncated cash flow, delivering liquidity over the specific requirements. Instead of accumulating cash reserves, organizations with a strong financial status can leverage the available cash through a buyback of shares in India.

●    Tax-effective option: Compared to dividends, share buybacks are highly tax-effective for organizations as well as shareholders. Remember that a buy-back of shares under Companies Act 2013 only attracts a DDT. The amount of money gets deducted before the distribution of the earnings to the shareholders. On the other hand, dividends come with three levels of taxation. 

●    Consolidating hold over the company: If the number of shareholders of a company becomes unmanageable, it becomes challenging to make unanimous decisions. It also leads to power struggles inside the organization and among different shareholders in terms of voting rights. Therefore, organizations often opt for an upcoming buyback of shares to consolidate their holding over the company and increase their voting rights. 

●    To indicate an undervalued stock: A buyback of shares can also indicate that an organization thinks that its shares are undervalued. This is a major remedy for the issue of undervalued stocks faced by companies. Moreover, this can help paint a positive picture of an organization in terms of its prospects and current valuation. 

The process of buyback removes cash from a firm's balance sheet and lowers the number of outstanding shares. Therefore, stock buybacks have a wide impact on the primary measures investors use to assess a public business.

It's critical to remember that whenever a corporation buys back its own shares, they are often terminated to reduce the number of outstanding shares permanently. At times, the shares are held by the organization in the form of treasury shares. These are not classified as outstanding shares, which has consequences for several critical financial aspects.

Key metrics such as earnings per share can be determined by using the number of outstanding shares to divide the net profit of the company. If you reduce the number of outstanding shares, you will provide a higher EPS to a company. It can often make a company seem to be performing better. 

The same thing is also applicable to the price-to-earnings ratio. It enables the investors to determine the relative valuation of a firm by comparing the stock price with its EPS. 
 

Investors frequently feel that the announcement of a buyback of shares indicates that the company's prospects are profitable. Furthermore, it is thought to have an impact on the company's overall stock price. For example, investors frequently feel that a stock buyback from shareholders is a likely indicator of the acquisition of large companies, the development of new and enhanced product lines, and so on.
Overall, a share buyback indicates that a company's stock valuation is about to grow. Notably, implying such optimistic prospects helps to attract the attention of investors who want to take advantage of such favorable situations.
 

Some key advantages associated with a buyback of shares are as follows:

●    Direct boosting of share prices: The primary goal of a stock buyback is to provide a high share price. Investors often notice a buyback as unparalleled confidence in the management of. 
●    Tax efficiency: A buyback of shares is ideal for achieving tax efficiency. 
●    Greater flexibility than dividends: Any business that begins a new payout or boosts an existing dividend must continue to make payments in the long run. This is because they risk lower share prices and dissatisfied investors if they reduce or cancel the dividend in the future. Meanwhile, a buy back of shares in India is a one-time event. Therefore, they are considerably flexible management tools.
●    Offset dilution: Developing companies are always looking forward to attracting talent. When they issue stock options to retain employees, the options implemented over time will spike up the total number of outstanding shares of a company. As a result, it will dilute all existing shareholders. But a buyback of shares can be an easy way of preventing this dilution. 

A few disadvantages associated with a buyback of shares are as follows:

●    Poor use of cash: A stock buyback can usually benefit short-term gains only. The cash might be used for some other more profitable purposes. 
●    Debt-fueled share buybacks: A large number of buybacks are facilitated by taking out a debt, which is seen as a short-sighted strategy. 
●    Cash-rich companies come with high stock prices: Following a period of strong success, certain companies that initiate a buyback of shares accumulate large volumes of funds. Companies in this position also have very high share prices, implying that they may produce less value for shareholders than alternate uses of cash.
●    Conceals stock-based compensation to executives: Many public firms compensate managers with shares, which might dilute other shareholders. Executives may use a share buyback to conceal the impact of this type of pay on the company's share count.
 

A buyback and a dividend are different methods of rewarding the shareholders of a company. These two methods also have varying significance. The key differences between an upcoming buyback of shares and dividends are as follows:
●    Dividend earnings are allocated to the current shareholders of an organization. Meanwhile, a buyback is perfect for existing shareholders who want to give up a specific portion of their shares. 
●    A dividend does not bring any difference in the total number of outstanding shares. But, an upcoming buyback of shares will reduce the total number of outstanding shares. 
●    Dividends are more regular and popular in India. But, the concept of a buy-back of shares in company law is comparatively new in the country. 
●    Dividends can be special, annual, regular, or one-time. But if you understand what is buy back of shares with example, you will realize that there is no variation.  
●    Dividends are taxed at three different levels. But, an upcoming buyback of shares will be distributed after the DDT deduction. 

Criteria Dividend Buyback of Shares
Beneficiary Existing shareholders Surrendering shareholders
Total number of shares No changes Gets reduced
Frequency More frequent and extremely common The concept of a buy back of shares is not much regular and is comparatively new in the country. 
Types Annual, regular, special, and one-time dividends No variations
Taxation Taxed at 3 levels Distributed after DDT deduction

Frequently Asked Questions

An upcoming buyback of shares 2024 can deliver multiple benefits, including an increase in share prices, tax efficiency, and greater flexibility. 

A dividend is different from a share buyback from various perspectives. For instance, a dividend is for existing shareholders, and a stock buyback is for surrendering shareholders. 
 

A buyback of shares does not have any types or variations. It is one of the major differences between a dividend and a share buyback. 
 

A buyback of shares can mean a poor utilization of cash for a company. At times, it can also fuel debt for companies. 
 

Share buybacks are leveraged by companies to give back profits to investors. By buying back their stock, the number of outstanding shares can decrease. Therefore, the number of remaining shares increases, which can be highly rewarding for shareholders. 
 

Dividends are paid only in the event of a company having a strong financial footing. Share buybacks offer much greater flexibility than dividends. Moreover, dividends are taxed at three levels. However, stock buybacks are distributed after tax deductions. Therefore, tax efficiency is one of the major reasons for choosing share buybacks over dividends.