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A buy-back is a corporate action where a company offers to buy-back its shares from the existing shareholders usually at a higher price than the market price.
I just read a very interesting story in which a shopkeeper loved his products so much that he went back to his customers and bought them all back.
I’m sure this sounds very strange to you but in the stock market, it happens quite often. This process is called a share buyback.
So today, let’s discuss share buybacks.
Welcome to our new series, Learn with Upstox!
I’m Aaditya Iyengar and in this series, we’ll be discussing some key aspects of fundamental analysis, corporate actions and some important general concepts about the stock market.
Let’s discuss the topic of share buybacks, in which we are going to talk about – what is the purpose of these buybacks? And what are the different ways this can impact the shareholders and the company?
What is a share buyback?
So, what actually is a stock buyback? They’re exactly what the name says. A company buys its own shares back from its shareholders. Now, there are a lot of advantages to this. Many companies just prefer a buyback to a dividend at times, because it improves the financial ratios of the company.
Now what does this mean?
Let’s consider the earnings per share. This is a measure that divides the company’s total earnings with its total shares. This gives us a figure for all profits made by the company per share. Now, if the number of shares is reduced, as in, the denominator of the equation reduces, then the final number or result increases. Therefore, buybacks are done to improve this ratio. As a bonus, the stock price also goes up by a little during a buyback because the total supply of shares in the market gets reduced significantly.
Sometimes buybacks are given preference over dividends. That’s because the objective is to give back profits to the shareholders, and if you can do this while also increasing your valuation, why not?
As an added advantage, buybacks aren’t taxed in the hands of the shareholder based on the most recent amendment. Whereas, the dividend is just added to your income and is taxed as per your income tax slab.
Another reason why companies do it is to make sure that the company’s promoters, which are the people who have started the company, get more controlling interest. This means that a buyback can also be done to increase the shareholding of an owner from say 51% to 55%.
So, we just saw how beneficial a buyback is, both to the company and its shareholders.
That’s it for now. Thank you so much for watching our video on stock buybacks, in our series, Learn with Upstox. I hope you learned something today.
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