Understanding Share Buybacks: Reasons, Benefits, and Process

Share buybacks, also known as share repurchases, are a strategic practice where companies purchase their own outstanding shares from shareholders. This process is carried out through either a tender offer or on the open market. The primary goal of share buybacks is to enhance the value of remaining shares and signal positive growth prospects. In this article, we’ll delve into the reasons, benefits, and process of share buybacks, shedding light on their significance for both companies and investors.

Share Buybacks Process

Companies typically repurchase shares by investing in themselves, believing their stock is undervalued. This increases the ownership proportion of remaining investors and boosts EPS. Buybacks also prevent dilution when issuing stock rewards or options to employees.

Reasons for Share Buybacks

Companies opt for share buyback for several reasons:

1. Effective Use of Excess Cash: When a company has excess cash but limited investment opportunities, share buybacks provide a prudent way to utilize the available funds.
2. Tax-Efficient Reward: Compared to dividends, share buyback are tax-effective for both companies and shareholders. They are subject to Dividend Distribution Tax (DDT) and are deducted before distribution.
3. Consolidating Hold: Buybacks allow companies to consolidate control by reducing the number of shareholders, preventing power struggles, and increasing voting rights.
4. Undervaluation Signaling: Companies often repurchase shares when they believe their stock is undervalued, sending a positive signal to investors.
5. Improving Valuation: Buybacks can improve overall company valuation and reward existing shareholders.

Benefits of Buybacks of Shares

Buyback of shares has significant impacts on a company’s financial aspects:

1. Earnings Per Share (EPS) Impact: Buybacks directly increase EPS by reducing the total number of outstanding shares, even if net income remains constant.
2. Financial Statement Effects: Buybacks affect financial statements, reducing cash holdings, total assets, and shareholder equity.
3. Positive Portfolio Influence: Buybacks demonstrate confidence in a company’s prospects, enhancing market reputation and shareholder trust.
4. Enhanced Shareholder Value: Companies with buybacks often experience faster EPS growth, attracting investors seeking income generation and growth potential.

Methods of Buyback of Shares in India

The practice of share buyback involves a company repurchasing its own shares from the market. In India, the regulations concerning share buybacks are governed by Section 115QA of the Finance Act, 2013, which is applicable to both listed and unlisted companies. Companies can undertake share buybacks through several methods:

1. Open Market: This method involves the company purchasing its own shares from the open market via a stock exchange.
2. Tender Offer: In this approach, the company invites its shareholders to offer their shares at a predetermined price during a specific timeframe.
3. Direct Purchase: Companies can directly approach their shareholders and acquire their shares through this method.

Tax Implications on Buyback of Shares

In accordance with Section 115QA of the Income Tax Act, domestic companies engaging in share buybacks are liable to pay an additional income tax known as Buy-Back Tax or Buy-Back Distribution Tax (BDT). The effective tax rate for this is 23.296% of the distributed income. The calculation involves a tax of 20%, a 12% surcharge, and applicable cess. Notably:

• The tax is computed based on the difference between the market price and the issue price of the repurchased shares.
• The tax liability falls on the company, not the shareholders.
• The due date for buyback tax payment aligns with the due date for advance tax.
• Shareholders aren’t subjected to any tax on this income.

Consideration for Buyback Tax Reevaluation:

Currently, both listed and unlisted companies are subject to a buyback tax rate of approximately 20%. However, there’s a growing sentiment among Indian corporates to revisit this buyback tax structure, prompting discussions for potential changes in the 2023 budget.

Significance of Share Buybacks

The announcement of share buybacks signifies positive company prospects and often influences stock prices. It suggests potential growth, new product launches, or acquisitions, drawing investor attention.

Dividends vs. Share Buybacks

While both dividends and share buybacks reward shareholders, they serve different purposes. Dividends distribute profits directly to shareholders, while buybacks reduce the number of outstanding shares, signalling positive growth.

Conclusion

Share buybacks play a crucial role in enhancing shareholder value, signalling growth, and boosting a company’s financial metrics. By understanding the reasons, benefits, and processes of share buybacks, investors can make informed decisions to maximise their returns and capitalise on the positive signals sent by companies engaging in this strategic practice.

FAQs| Share Buyback

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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.