A stock by back can be seen as a method of company investing in itself by buying the shares from other investors. Buybacks reduce the number of outstanding shares in the market. It is done through various transactions like open market stock exchanges using book building process, through offer documents and through the share holders.
But why do company’s option out the buyback procedure? and is it in favour of the shareholders?
The following are the reasons:
Liquidity of shares: A buyback generally shows that the company is having a good cash flow standing and has excess cash on hand.
Enhancing the balance sheet ratios: By undergoing the buy back process the company can increase their profitability ratios showing a concrete standing in the market. Buybacks will affect the EPS and the P/E ratio as they are directly linked with the net profit and the market price of the shares.
Shareholders benefit: One side of the buyback will show some positive notifications but sometimes buybacks are done when the company is facing turmoil. With the threat of a merger or takeover, the company will purchase all its shares in order to protect the interests of its current investors. Once a buyback is initiated a strong position of the company to be acquired is portrayed and thus this makes it difficult for a take over.
Over valuation of shares: Sometimes company’s want their share prices to be overvalued so that the shareholder standing increases and they enjoy huge profits.
Buyback or dividend: Buybacks are solely done in the interest of the shareholders and thus this could be substituted by dividend distribution. Both which way the shareholders are at a benefit as the number of outstanding shares reduce in the market and the ownership of these shares increases.
On the whole stock buy backs are generally an outcome of some positive decisions taken by the company but investors should be vigilant as a few companies inflate share prices, through this method, without even having that kind of standing in the market.