• HDFC securities
• 22 Feb 2023
• Knowledge Centre

 

 

A stock market is a place where companies raise capital by issuing shares to the general public and institutions. It is a platform where investors/traders meet to indulge in buying shares, bonds, mutual funds and other securities. If you are familiar with the stock market, you must know how shares are issued by companies with the objective of raising capital. However, the companies may also repurchase the shares issued to the public. This is known as the buyback of shares.

Learning about buyback can help you broaden your knowledge of how the stock market functions and make the most of how you can earn a profit.

 

What is Buyback of Shares?

Before getting to the details, it is important to understand the meaning of buyback of shares. Buyback of shares is also known as a share repurchase and refers to a corporate action wherein a company buys back its shares from shareholders. Thus, it almost functions as the opposite of an initial public offering (IPO). The upside for shareholders is that during a buyback, a company is likely to purchase the shares at a price that is higher than that prevailing in the market price.

Usually, there are two types of buyback of shares. They are as follows:

• Tender offer:

Under a tender offer, a company buys back its shares at a particular price. This is called the offer price. The shareholders can then tender their shares or sell their shares at this price.

• Open-market offer:

As per this method, the company buys back its shares in the market from sellers on the stock exchange. The buyback period is mentioned in the offer.

 

 

What is the Reason for Buyback of Shares?

Apart from the shareholders, the buyback of shares benefits the company as well. Here are the primary reasons why a company would opt for a buyback of shares:

• Excess Cash

Often larger blue-chip companies find themselves sitting on a lot of cash and do not have enough projects to invest in. Hence, it is wiser for companies with excess cash on the balance sheet to return the funds to shareholders by buying back their own shares.

• Increase in EPS

After a buyback, the number of outstanding shares of a company in the market is reduced. This is likely to result in higher earnings per share (EPS). Hence, a company may opt for a buyback to increase its EPS.

• Increase in Share Price

Buybacks are also done to boost share prices. As the number of shares in the market reduces, their prices tend to increase. Moreover, a company announcing a buyback also looks financially sound and attractive, thereby increasing investor participation.

• Increase Promoter Holdings

Another reason for going ahead with a share buyback is to increase the shareholding of promoters in the company.

Share buybacks are a useful tool for companies as well as investors. It helps companies to raise the value of their shares and provide liquidity for shareholders, among others. However, investors must consider the risks associated with share buybacks and make informed decisions in the markets.