Buyback of Stocks

Buyback of shares is a term that refers to a situation where a company buys back its own shares with its own capital.

A buyback of shares reduces the equity capital of a company. This happens because the shares bought back from the market are extinguished and cease to exist. The Company's Act debars the company from reissuing these shares again. As a result, not only does the equity capital reduce, but also the floating stock of the company's shares in the market shrinks to a lower level. Consequently the earnings per share (EPS) go up because the same amount of net post tax earnings (as before the buyback) get spread over the reduced equity capital. As a consequence, the shares of the company get a better discounting, or P/E multiple, on the bourses and their price appreciates to a level that is considerably higher than the pre buyback level.

Sometimes the buyback announcement indicates the company management's belief that the market has undervalued its shares and that they deserve a higher price. Such cases too result in a significant appreciation in the price of the company's shares, as a result of the great confidence in the value of its shares shown by its management.

Sometimes, company managements buy back their shares with a view to reducing the public holding in their company, as a step towards de listing of their shares from the stock exchanges. When this happens, it usually has a dampening effect on the price of a company's shares. However, as a saving grace, shareholders do get ample opportunity to exit the company at better than market prices.

The buyback of shares by a company is usually announced at rates, which are higher, sometimes considerably higher, than their current quoted prices on the market. This gives investors an opportunity to make a windfall profit that they would not have got on the stock exchange under normal circumstances.