Share buyback refers to the process wherein a company repurchases its own shares from existing shareholders. A share buyback leads to a reduction in the company’s outstanding shares and is generally done to demonstrate that the company has sufficient cash reserves.
The company gives an offer to its shareholders to tender shares at a particular price which is generally higher than the prevailing market price.
A buyback of shares takes place via a tender offer or open market offer. As far as tender offers are concerned, the existing shareholders opt to accept the offer put forth by the company and tender their shares. This is done on a record date and in exchange for cash as offered by the company according to the prescribed buyback ratio.
On the other hand, an open market offer allows any equity shareholder of the company to participate in the buyback process. They can do so through their stockbroker while the buyback window is open.
Buybacks allow a company to regain control of its shares by repurchasing those held by shareholders. It also helps a company reduce the quantity of shares held by the general public. Buybacks help a company consolidate its ownership and improve its valuation. It is also instrumental in rewarding shareholders.
Buybacks allow a company to increase the value of shares, and in turn, improve the overall valuation of the company. Along with fostering trust amongst investors, they are also a tax-effective way of rewarding investors, especially when compared to dividends that are taxed thrice. Additionally, buybacks boost the price of the company’s shares while reducing supply within increased demand.
One of the major drawbacks of buybacks is that they give a false illusion about the company’s valuation. Similarly, the reduced supply of shares even when demand is high can drive up prices giving a false illusion to investors.
If you want to participate in the tender offer buyback process, you must be an existing shareholder of the company on the Record Date of the buyback offer. On the other hand, any shareholder holding shares of the company can participate in the buyback offer under the open offer process.
A record date is a date set by the company to determine the names of the equity shareholders eligible to participate in the buyback. The shareholders whose names are registered in the company’s book as of the record day are only eligible to participate in the share buyback.
Generally, a buyback has a positive effect on share price due to the shortage of supply as the company repurchases shares. Another reason is that investors’ confidence increases as only a financially healthy company can opt for a buyback. As the number of outstanding shares reduces and the earnings remain the same, the EPS (earning per share) improves, causing a price hike.
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