Buy Back of Shares by Company- What it is and should you opt for it.
Sometimes a company has surplus funds which it does not want to use for expansion or growth. Such a company can announce a ‘buy back’, wherein it will buy back the shares from its shareholders at a pre-decided price.
Company ABC Limited has huge cash reserves amounting to Rs. 5 crore in its balance sheet. The share capital of the company is Rs. 1 crore divided into 10 lakh shares of Rs. 10 each. The company decides to buy back a part of its capital amounting to 2 lakh shares. Thus the remaining share capital of the company will reduce to 8 lakh shares and company will distribute a part of its cash reserves to shareholders from whom shares have been bought back.
Impact of the buy back
Buy back indicates that the company has surplus funds that it would like to distribute to its shareholders rather than investing the same for future growth. Thus it indicates that the financials of the company are on sound footing. Post buy back, the earnings of the company will have to be divided by reduced number of shares.
Earnings Per Share (EPS) = Net profit / number of shares
Since the profits remain the same but the number of shares has decreased, the EPS will rise. Thus sometimes buy back is also used by the company to shore up the market price of the shares.
Shareholders whose name figures as per the books of the company on record date are eligible for buy back. However if you are holding shares in physical form and still not transferred these shares in your name, you can still participate in buy back by tendering transfer deed as well as buy back offer form to the company or its registrar.
Should you opt for it?
Following factors are worth consideration when a company comes out with a buy back offer:
• The attractiveness of price at which buy back offer is made. If it is near current market price and there are expectations that market price may rise, there may not be good reason to opt for it.
• The future growth potential of the company. If the company is poised for good growth, its share price may go up further as compared to buy back price.
• If the intrinsic value or book value of shares is more than the buy back stock price, there are possibilities that the share price may go up further and it may not be an appropriate time to exit.