The Indian market has observed contrasting opinions regarding stock buybacks. Some investors think they're a waste of money, while others think they're a great method to give stockholders tax-advantaged profits.
A stock buyback is a type of financial transaction in which an organization uses cash to buy back its previously issued shares from the market. When a business buys back its own stock, it lowers the total number of outstanding share. Repurchased shares are either cancelled or kept in the company's treasury because a corporation cannot be its own shareholder.
Why do companies implement stock buybacks?
Stock buyback is one of the main ways a business might utilize its cash, along with investing in operations, paying off debt, purchasing another business, and giving investors dividends. Besides that, there are various other reasons for a company to repurchase its shares. These are-
- The management of a firm may opt to repurchase part of its shares from the market in order to raise the price of the remaining shares if they feel that the stock is undervalued.
- Stock buybacks are frequently started by companies that provide stock options to their workers as part of their pay packages. The rationale for this practice is that it raises the number of shares outstanding when workers of the firm exercise their stock options.
- The management of a target firm may, as a defensive measure, repurchase part of its shares from the market if a hostile takeover is threatened. The defensive approach seeks to reduce the acquirer's likelihood of acquiring a controlling stake in the target business.
- Each shareholder may control a higher proportion of ownership in the firm than they did before the buyback if the total quantity of shares on the market is reduced as a result of stock buybacks.
How does stock buyback impact the shareholders?
The pros and cons of stock buybacks mostly rely on who is conducting them, when, and why. Repurchasing shares while neglecting other objectives is almost likely a massive mistake that will end up costing shareholders in the long run.
However, it is possible that the business may spend money on buybacks after making wise operational investments. Due to the company's emphasis on making profitable investments with shareholders' money, it may be a wise investment. Additionally, a management team that prioritizes shareholders is an indicator that your investment will grow in the future.
In reality, things rarely pan out precisely as planned. On the one hand, even before the firm has actually purchased any shares, the mere announcement of a stock buyback plan might occasionally raise the price. On the other side, occasionally bad news breaks or the market changes as the corporation is purchasing its own stock.
Over the years, legendary investor Warren Buffett has discussed the benefits of stock buybacks constantly and has referred to their disciplined usage as the surest method for a firm to utilize its wealth wisely.
