Share Buy Back - What Is The Purpose?

The concept of Share Buyback!!

In corporate finance, share buyback is an important concept, which makes it an approach that we, as investors, should investigate critically.  
First, let us understand what stock buyback is. In case of buyback, the company will take back some of its shares from the market at a much higher price compared to its current market price. Therefore, if you return your existing shares to the company, it is similar to selling them off in the market but at a considerably higher profit, with zero risk.

Opportunity..

However, good companies offering stock buyback opportunities at a very high price typically receive bids beyond their actual number of share buybacks planned. So, even though you may submit your bid on time, you may not always get the chance to take advantage of the offer.

Purpose..

1. Now, let us see the purpose of the buyback of shares. When a company wants to raise money, it will issue shares to the general public. However, the case may also be the opposite, i.e., the company has a lot of excess funds with it due to high profits or reserves. In such cases, the company may want to give some of it back to the shareholders to keep them happy and satisfied. A few ways to do so is to declare a good dividend or a share buyback. Therefore, through buyback, the company gives its shareholders the chance to sell the shares and earn a guaranteed return without risk. This enhances shareholder value by increasing its earnings per share (EPS), boosting the stock prices, which finally helps the company restructure. 
2. A company may also use share repurchase to inform shareholders that its shares may be undervalued and that the company is confident in its future growth potential. By offering to buy back the shares at a higher price, the company increases shareholder confidence again. 
3. This method of share repurchase also provides a tax-efficient return because dividends are taxed at a higher rate than repurchases. Therefore, shareholders find it a more lucrative option. 

Example: 

Innovate Inc. is a U.S.-based tech company, holding excess cash of $10 million. Thus, with a stock price is $50 per share, and outstanding shares of 10 million, its market capitalization is $500 million. 

The company initiates a share buyback program, where it repurchases 200,000 shares from the open market, giving the respective shareholders, who sell their shares, cash at the market price of $50 per share. This reduces the outstanding shares to 9.8 million. Now, since the net income is divided among fewer shares, the company’s earnings per share (EPS) increases.

The above situation can lead to a higher stock price, improved metrics and better confidence of shareholders in the business. Innovate Inc. uses the buyback to reward its shareholders while optimizing its capital structure, ensuring its financial strategy aligns with creating long-term value.

Conclusion

To conclude, share buyback is when the company repurchases its own shares, reducing the total in the market, which is a way of showing confidence as well as enhancing earnings per share, capital efficiency, and strengthening company’s position. This is a reward for the shareholders. 

I hope the above example along with the explanation provided a wholesome view and understanding of the concept. 

Related Blog: 

• 7 Key Pointers For Investing In Stock Market
• Is It Good To Invest In Falling Stocks?