Understanding Share Buyback: Benefits, Risks, and its Financial Impact

Post Date : March 24, 2025

Understanding Share Buyback: Benefits, Risks, and its Financial Impact

Disclaimer- Investments in the securities market are subject to market risks. This content is for educational purposes only and does not constitute any financial advice.

Share buyback refers to the practice of firms buying back their own shares from current owners, either through an open market transaction or a tender offer. The price of these shares is typically higher than the existing market price.

Companies can repurchase shares via the secondary market if they opt for the open market process. However, those who choose the tender offer can submit a part of their shares within the allotted time. Buybacks serve as an alternative method to reward shareholders besides paying dividends.

KEY TAKEAWAYS 

• In a share buyback, companies repurchase their outstanding shares from shareholders.
• Share buybacks increase promoters’ control and enhance earnings per share (EPS).
• The key advantages of share buyback include efficient use of cash reserves, protection against hostile takeovers, and positive growth prospects.
• Some drawbacks of share buyback include potential miscalculation of company valuation and delays in major investment projects.

Reasons for Buyback

A company may have several reasons for conducting a buyback:

1. Share buybacks lower the capital base, leading to higher earnings per share (EPS).
2. It acts as a defense mechanism against corporate takeovers by increasing promoters’ holdings.
3. Buybacks provide flexibility by allowing companies to reduce their equity base when necessary.
4. They reduce the floating stock ratio, increasing the shares’ intrinsic value.
5. Repurchases allow businesses to expand their capital bases without raising additional funds through mergers and acquisitions.

Different Methods of Share Buyback

1. Buying from the Open Market

• The company purchases its own shares from the market through brokers.
• Buyback programs may last for an extended period and can be modified based on business requirements.

2. Tendering

• The firm issues a tender to buy shares from existing shareholders at a fixed price, usually above the current market value.
• The buyback proceeds are based on investor participation.

3. Repurchase by Direct Negotiation

• Companies negotiate directly with major shareholders, offering a price higher than the existing rate.

4. Dutch Auction Tender Offer

• Instead of a fixed price, a price range is offered, allowing investors to place bids within that range.

Financing Aspects of Buyback

Companies require significant funds for buybacks, which can be arranged through:

• Internal funding from profits
• Maintaining adequate cash reserves
• Selling short-term investments
• Issuing fixed deposits, loan bonds, or debentures
• Loans and overdraft facilities from banks

Share Buyback vs. Dividend

Impact of Share Buybacks on Financial Metrics

Share buybacks decrease the number of outstanding shares, increasing EPS and making the company appear more profitable per share. This also improves return on equity (ROE) and affects the price-to-earnings (P/E) ratio. However, buybacks do not alter actual operational performance and should be evaluated alongside other financial indicators.

Advantages of Share Buyback

1. Efficient use of excess cash reserves.
2. Alters capital structure, balancing equity commitments.
3. Signals confidence in the company’s future prospects.
4. Provides a defense against hostile takeovers.
5. Increases promoter control over the company.
6. Enhances EPS and P/E ratios.
7. Helps firms with high liquidity optimize capital use.
8. Leads to higher dividend yields post-buyback.

Disadvantages of Share Buyback

1. EPS and ROA ratios may rise artificially due to reduced shares rather than increased profitability.
2. Misjudgment of company valuation by management could lead to ineffective buybacks.
3. May hinder major investment projects by utilizing cash reserves.
4. Can be used unethically to increase promoter holdings.

Regulatory Measures Governing Share Buyback

Share buybacks are governed by the Companies Act, 2013, and SEBI (Buy-Back of Securities) Regulations, 2018. These regulations specify:

• Maximum buyback limits and methods (tender offer or open market).
• Cooling-off periods before another buyback can be initiated.
• Solvency requirements and shareholder disclosure obligations.

Conclusion

A share buyback allows companies to repurchase outstanding shares, offering benefits such as increased EPS, enhanced promoter control, and better capital allocation. However, stockholders should carefully evaluate buyback proposals considering financial needs and risk tolerance before making decisions.

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