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A buyback is a wise investment of the company

A buyback is a wise investment of the company

A buyback is a wise investment of the company

A buyback is a wise investment of the company

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Warren Uncle says that the best investment you can do is “INVEST IN YOUR SELF”.

As the name defines the action, In this company repurchases its shares from the market at a particular price.  

Companies do invest in their own shares which they buy from existing shareholders. 

Deep Down: Buy Back

A stock buyback allows companies to invest in themselves. The shares which are freely changing hands in the market get reduced. Sometimes the management of the company also feels that their company’s stock price is a deal. Since the management knows better than a retail investor. Management is also confident about their company’s business. In our previous articles, we wrote about PE Ration where we also discussed its formula.
 
Now considering that formula, If the PE ratio is maintained then the stock price will price.
 
Now Consider the company repurchasing the existing shares which are in the market. Due to this, the stock’s EPS will rise and the PE Ratio will go down, and the share price will rise.
 
the number of shares (as in the denominator) of the formula of EPS has decreased so the EPS will increase.
 
In the formula of PE Ratio EPS Will decrease then stock price in the numerator will increase keeping the same PE Ratio. 
 
Formula Used here:
 
PE Ratio: Stock Price/EPS 
 
EPS = Earnings of the Company/No of Outstanding shares.
 
Substitution Formula using both. 
 
PE Ratio = (Stock Price X No of Outstanding shares)/Earnings of the Company.

Why do companies go for buyback?

There could be n number of reasons for a company to go for a buyback of shares. 

we have tried to explain some of them below:

  • Excess Cash: Most companies have excess cash in the books of accounts also they have fewer investment opportunities in the market so buyback is the right option over here. 
  • Tax benefits: Buybacks are most tax-effective than dividends for both investors and companies. In a buyback, tax is levied only once which is based on DDT but in the case of dividends, taxes are levied on three different levels. 
  • Green Flag: By announcing the buyback company is telling investors that the company is still undervalued. 
  • Valuation of Companies: When BOD announces a buyback, the number of shares is going to reduce and EPS will also be going to increase, which I have discussed in the above para. This will result in a better valuation of the company.
  • Cash to Existing Investors: companies are allowing the existing shareholder to get more cash in exchange for the share which they are holding. 
  • Shareholding Percentage: As per the guidelines issued by SEBI, sometimes promoters may be concerned that their holding in the company will fall below a certain level. A buyback is just a proposal from the company to existing investors, it purely depends on the existing shareholders whether they want to accept it or not.
  • De-listing of shares: Companies are closing their operation in a specific country so they try to take their shares back from the existing shareholders from the same country. 

Post buyback

  •  The number of outstanding shares decreases and EPS increases due to which, stock price increases.
  • Buyback can also be considered as a promoter’s confidence. 
  • In a recession, companies can come up with buybacks so that they can get their shares back at a cheap valuation. 
  • buyback can also be done to create a barrier for other investors who are trying to control and claim maximum shareholding.

Dividends vs Buyback

Well, these two are considered as a hint for the investors that the company has no opportunity in the future for growth. Management of the company is in dilemma about the cash of the company. 

Post dividend you will be considered as a shareholder but post buyback(if accepted by the shareholder) you won’t be considered as a shareholder. 

Three types of tax are levied on dividends. Buybacks are based on past DDT deductions. 

Dividends are regular but buybacks are not. 

Generally, there are three types of dividends but there is no specific type of buyback. 

The number of outstanding shares that are floating freely in the market is going to reduce post buyback, but these shares are not going to reduce in case of dividends.

You don’t need to apply for buyback without research, Before making a decision, you should go ahead with your analysis of the company. Try to check whether management is buying shares of their own company or not. If they are buying then it is a GREEN FLAG.
 
A stock buyback allows businesses to reinvest in themselves. you have to accept the fact that management knows the company better than you and retail investors.
 
They know whether the stock price is overvalued or undervalued.
By doing buyback share value also increases in the company itself. Buy can also be used as a barrier so that other companies can’t take control over it.
 

We hope We gave you some insights about buyback and delivered it in the best possible way. 

Let us know what you think about the buyback. leave your precious comment, and We will respond to it. 

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To your Investing and Financial Journey

Cheers

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RuPay Rajat

Making Finance Easy

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