It is quite a familiar term and you will every now and then hear a company buying back its shares from the market. What it means is that the company will buy its own shares from the existing shareholders by paying something in excess of the market value.
Share buyback is mostly aimed at improving stock valuation. Once the number of shares are reduced parameters such as earnings per share (EPS) will improve which will boost share prices. It is also a more tax efficient way to distribute wealth among shareholders compared to dividends as unlike buybacks, dividends are taxable.
Those shareholders who sell their shares to the company during buyback benefit from the premium that they get above the current market price.
From the Company’s point of view, a buyback will lead to increase in promoter’s holding which will again improve the company’s valuations.
A company can buyback through:
- A tender offer, or
An open market.
- Tender Offer: The company presents an offer to purchase a particular number of shares at a definite price, straight from its shareholders. The offer is valid till a certain declared date after which it is exhausted. It is basically a transaction that is off-market.
- Open Market Option: The company purchases number of shares that is equal to or less than an announced number. There is no obligation to buy the entire quantity declared. The buyback can be done up to the maximum price that is fixed beforehand. The process generally continues for a year. The basic objective behind such a procedure for buyback is buying the highest possible number of shares at the lowest price possible, remaining within the unchanging overall limit. This is likely to maximise the shareholders' value for the remaining shareholders.