As per recent news, the global FMCG giant Unilever has announced a €3 billion share buyback after posting blockbuster sales growth in the first quarter of 2021. Thanks to the whopping sales of Hellmann’s mayonnaise and Magnum ice cream across the globe. Similarly, tech giant Apple Inc has also announced a $90 billion share buyback program as the sales of its 5G iPhones continue to skyrocket across the world, with sales figures nearly doubling in China alone.
So, what exactly is share buyback? Why do firms repurchase their own shares at different points in time? How does it benefit firms and shareholders? Is it good or bad? Let us find answers to all these pertinent questions in the succeeding paragraphs.
Share buyback
A share buyback is a transaction in which a company repurchases its outstanding shares from the marketplace. The company may either repurchase its stocks directly from the secondary market or give its shareholders the option to tender their shares to the company at a fixed price within a given timeline.
You would require a demat and trading account to participate in share buyback intraday trades. Many brokers these days allow you to open free trading accounts online. You can also bid for buybacks using your free trading account.
Is demat account free? The answer is ‘yes’. Many stockbrokers allow you to open demat accounts also online at zero cost.
Reasons for share repurchase
There are several reasons due to which organizations may resort to share buybacks. Some of the most common reasons have been highlighted below:-
- Excess cash reserves
Usually, companies issue shares to raise capital from the market to fund their business expansion plans. However, many times, potential investment projects may not materialize and companies may be left with excess cash – much higher than their liquidity requirements. Under such circumstances, companies may use the surplus cash to buyback stocks.
- Equity base reduction
Shareholders enjoy ownership and voting rights. Thus, many times, when the number of shareholders of a company exceeds manageable limits, arriving at a consensus during major corporate decisions may become tough. Hence, the company board may resort to share repurchase to reduce the number of shareholders. Companies often engage in buybacks to prevent hostile takeovers too.
Consequently, EPS (Earnings Per Share) increases, as the total number of outstanding shares have decreased. With reduction in cash holdings and equity base, metrics like RoA (Return on Assets) and RoE (Return on Equity) will also improve. The firm’s overall cost of capital reduces and existing shareholders’ wealth increases in the process.
- Enhanced market reputation
Usually, share buybacks affect investor sentiments positively. It is believed that companies generally repurchase shares when they consider their stocks undervalued. Plus, companies engaged in stock repurchases are considered to have considerable pricing power and market influence. Hence, a firm’s brand equity as well as stock valuation usually increases soon after a buyback announcement.
Pitfalls of share buyback
Many times, the stock price of a company falls soon after a buyback implying that the company’s financial health might not be great. This could also be the consequence of a negative investor sentiment stemming from the investors’ perception that the concerned company doesn’t have enough projects in its kitty. Hence, the firm’s revenue generation potential is likely to be low in the future. Moreover, buybacks may increase the promoters’ stakes and control in the company.
Final words
Share buybacks have their own pros and cons. If you are an existing shareholder of a company engaged in share repurchase, you may be able to make profits from intraday trading by selling your shares at a premium. Conversely, you may lose money if stock prices plummet soon after a buyback. Thus, you may exercise caution and due diligence while executing intraday trades of stock repurchases.
Also read:- What is the Perfect Strategy for Share Trading after Retirement?
