Share Buyback: What is it and is it beneficial for a shareholder?

Introduction

Profit-making public companies have various methods of utilizing excess cash, the most common being dividends. However, they can also choose to reward their investors with stock or share buybacks. In this blog, you learn about what share buyback is, how to bid for share buyback, and what its benefits are. 

What is Share Buyback?

A share buyback or stock buyback is when a company buys back its own shares from the market using excess cash. All these repurchased shares are eventually used by the company, while the number of outstanding shares goes down, which drives up the share value. 

How to Bid for Buy Back of Shares

Interested in knowing how to bid for a share buyback? There are mainly two methods:

● Via tender offer 

● Via the open market

1. Tender Offer

The shareholders of a company get a tender offer that requests them to tender or submit either a part or all of the shares they own within a stipulated time. This offer states the number of shares the company intends to buy back and the price it wishes to offer. Investors accepting this offer mention the number of shares they are ready to tender alongside the price at which they are ready to accept the deal. After receiving all the offers, the company will find the best mix to purchase back the shares at a considerably low price. It is typical for a market to consider a buyback as a good sign for the company.

2. Open Market

A company can buy back its shares from the open market at the current stock price. However, as mentioned above, the share buyback plan by a company eventually results in the price of shares going up, as it is considered a positive sign for a company's business position. 

Why do Companies Repurchase Shares?

Companies buy back their own shares primarily to create value for their shareholders. Wondering how it works? 

A primary goal that most corporate houses have in mind is to maximize their shareholder value. Based on this principle, a business must always intend to generate the greatest possible returns for all its investors. Share buyback helps a company do just that – share prices rise when it buys back its shares. This creates demand when the supply is less, pushing the share price even higher, thus creating more value for shareholders. 

Benefits of Share Buyback 

While dividend payments are one of the most common techniques to return cash to shareholders, share buyback has far more benefits. These are as follows:

● Boost the share prices: The prime goal of any share buyback program is to increase the share price. The board might feel that the shares of its company are undervalued, so it can decide to buy them back. Investors, in the meantime, can think of a buyback as a sign of management having confidence in the company’s growth; otherwise, why will a company wish to buy back shares declining in value?

● Tax benefit: Dividend payments are always taxed as an income, whereas rising share prices aren’t. Any shareholder selling their shares may naturally recognize some capital gain taxes. In contrast, shareholders who do not wish to sell the shares reap the benefits of a higher share worth and no additional tax. 

● Added flexibility to the dividends: When a company gives dividends, then, in a way, it sets up an expectation – the investors come to expect that the dividend amount will not go down from the current level. However, stock buybacks establish no such expectations. 

● Offset dilution: Several public companies have stock options for their employees. When they leave the company and exercise the options, the company's total outstanding stocks rise over time, diluting the existing shareholders’ value. The best way to offset this kind of effect is through share buybacks. 

Conclusion

If a public company is performing well and has excess cash in hand, and its shares are undervalued, then a buyback is a positive sign for the shareholders. Suppose a company is buying back shares while it neglects other segments of the business or is holding back on investing in any future growth. Now, in this case, this decision might impact the shareholders’ value. If the shares of a company are overvalued, then the shareholders would rather benefit in the long term if the company held on to the excess cash. 

FAQs

Is share buyback good for the shareholders?

Public companies use share buyback to return profits to their valued investors. Share buyback reduces the number of outstanding shares, increasing the stock price. This is a good sign for the shareholders. 

What makes a share buyback different from a dividend?

A public company uses dividend payments and share buybacks to return excess cash to its investors. With the dividends, it directly makes cash payments to all its shareholders, whereas with the share buyback option, it offers to buy its own shares back from the shareholders. 

Can a company pressure me to sell the shares I have?

Never! The share buyback definition also highlights that a public company does not have the privilege of forcing you to sell the shares you have as a part of its share buyback plan.