From the outside, many people may view the share market as a place to trade or invest in a company’s shares. However, once they open their Demat account and trading account, they gradually realize that the share market is a much more complex entity. It entails more than just buying and selling shares to make profits. Investing in the share market demands understanding the different types of stocks, researching the underlying companies, and risk management. At the same time, it involves keeping track of events like a stock split, bonus, and share repurchase. In this article, we will learn what a share buyback is and whether it is good to participate in one.
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What is Share Buyback?
A share buyback or repurchase is a special event where the company decides to buy its shares from investors. So, in other words, when a company buys back its shares, it is investing in itself. After the share repurchase, there is a reduction in the total number of shares in the open market. The company’s board may propose a buyback and its shareholders approve of it. The board could advocate for a buy for different reasons that we will look at later.
How Does a Share BuyBack Work?
If you happen to be a shareholder in the company, you will receive an email to e-vote in favor or against the proposal of a share buyback. If the majority of the shareholders vote in favor of a buyback, the buyback process begins. The company puts forth the tender offer, which is nothing but the buyback offer. The company mentions the number of shares it wishes to repurchase, its total value, and the price offered for each share. The buyback offer price per share is a premium to the current share price. Investors have to apply to participate in the share buyback within a window provided by the company.
Participating in a share buyback event allows you to tender your shares using your trading app/platform. The acceptance ratio of the tender share depends on the buyback size and number of tendered shares. Since the number of shares tendered often exceeds the quantity the company wishes to buy back, the company will not repurchase all of your tendered shares. However, SEBI (Securities and Exchange Board of India has made a 15 percent reservation mandatory for retail investors.
Reasons for a Share Buyback
One of the primary reasons a company may purchase its shares is because it believes its shares are trading below their fair value. The management and board of the company know the potential to which the company can scale its operations. When a company scales its operations and profitability, the value of its stock will certainly appreciate. And since the number of shares in the open market reduces after a share buyback, the stock’s EPS (earnings per share) increases. At the same time, its PE ratio or price-to-earnings ratio decreases. The PE ratio is a metric that investors refer to while analyzing stocks and generally prefer stocks trading at a lower PE.
A company may also buy back its share for compensation purposes. It is a common practice for companies to reward the management and employees by awarding them with shares. That is because companies do not prefer diluting their existing stake and distributing it to their employees. In contrast, they would prefer to distribute the shares by repurchasing them from the market. Or, it may just be that the company is sitting on a lot of excess cash and wants to reward its shareholders through a buyback.
Should You Take Part In a Share Buyback?
Now that you know what is share what is share buyback, should you take part in one? To participate in a share buyback, you must have a Demat account and trading account, and be an investor in the company repurchasing its shares. When a company declares a share buyback, it may result in many investors purchasing the shares of that company to participate in the buyback. However, remember that the company will not repurchase all the shares you tender. So whether or not you should take part in a share buyback depends on how you evaluate the company’s growth, the potential reason for the buyback, and your financial objectives.
Investors view a buyback as an instant way to make profits. If you already happen to be an investor in the company before the company announces the buyback, if you believe the buyback price is fair, are looking for an exit, or require cash, you could consider participating. If a company you do not own announces a buyback, you can still consider participating. Provided you have a proper investing strategy and do not mind holding onto the leftover shares with you.