Sep 7, 20214 min read

Massive stock BUYBACKS of 2021: By Palak Kaur

“The most important ingredient for success in the stock market is a sharp sense of timing” - Venita VanCaspel

WHAT IS A STOCK BUYBACK?

A stock buyback is a financial transaction in which the companies purchase back their shares from the market that were lent out before. It is also one of the ways how the companies can return wealth to their shareholders. It is also seen as a way in which the companies can re-invest in the company. Since the companies are buying back their shares from the market, the number of company’s outstanding shares reduces in the market.

With the buyback programs of the companies, the number of investors decreases. Since there is a reduction in the investors, the ownership of each investor increases relatively.

TYPES OF BUYBACK

The buyback works in two forms. One is through the open market and the other is through the tender offer.

A tender offer is issued to the shareholders. In this, the company states the number of shares they want to repurchase and the price to be repurchased. The tender also asks the shareholders to submit a portion of their shares within a certain period that can be repurchased by the company. The investors who are willing to participate in this repurchase set a price for the shares that they are willing to sell for. Once all the investors state their offer to the company, it is the company’s turn to decide on the combination of shares so that they have to pay a minimum price for it. The company can also buy back its shares from the open market at the current market price of its shares.

The current year has seen a lot many companies opting for a shares buyback program.

Some of the companies opting for it in the current financial year has been listed below:

VIEWS OF MANAGEMENT OF A COMPANY ON THE BUYBACK PROGRAM

The buyback program of a company is considered to be a good decision by the market. As in most cases, it has been seen that there has been an increase in the price of shares post the buyback program.

On taking the views of the management of a company, it can be said that share buybacks are the best form of capital investment for a company. This increases the return for the shareholders as there is an increase in the value of the shareholders. Another instance in which the company takes the initiative of the share buyback is when they see that there is a huge reduction in its current share price in the market. The reduction in share price mainly happens due to setbacks in the economy or due to some illegal means in accounts. The companies invest crores of rupees to buy back their shares once discounted in the market. This has been seen to be a positive sign for the company shortly.

IMPROVEMENT OF FINANCIAL RATIOS THROUGH BUYBACK

The company also issues buyback of the shares to improve their financial ratios. These ratios are greatly helpful to the investors in deciding their portfolios. This is a good corporate decision as well. Firstly, it is seen that the buybacks reduce the number of outstanding shares of the company in the market. These shares are kept as treasury shares by the company which reduces the number of outstanding shares in this process. There is also a reduction of assets in the company in the balance sheet. This further reduces the cash. Since the assets reduce, there is an increase in return on assets (ROA). The outstanding equity also reduces thus increasing return on equity (ROE). The high ROA and ROE of a company are observed to be better by the market.

Secondly, the share buyback also improves the price-earnings ratio(P/E) of the company. The P/E ratio is most used when the measure of the value of the shares is concerned. Shares buyback also reduces the ownership dilution of the company. This dilution is mainly caused by the employee stock option plans (ESOP). There are times when a strong labour force is created by strong economies. The companies in this case have to retain their laborers. For this, they come up with many ESOPs. ESOPs have a negative effect as compared to buybacks as they increase the number of outstanding shares of the company in the market. This affects the EPS and P/E ratio of the company. This weakens the financial position of the company. This can be compensated by the repurchase of the shares by the company.

ADVANTAGE OF BUYBACK OVER DIVIDENDS

Shares buyback is considered to be an alternative way of giving money to their shareholders and is often compared with giving them dividends. The buybacks hold an advantage over distributing dividends in terms of payment of taxes. The dividends are taxed on the normal income tax criteria when they are received but the repurchases are taxed at a lesser amount, i.e., at the capital gains tax rate. This is an added advantage for the investors of a company.

CONCLUSION

The question of whether share buybacks are good or not can have a different dimension depending on the current financial position of a company. But looking at the share price of the company, the values always increase post a buyback which further gives an advantage to the economy of the country in the long run even if the assets of the companies reduce in the short run. Buyback programs strengthen the position mostly in terms of goodwill of the company in the market.

Don’t you sometimes think it is just a mind game???