October 13, 2024

Share or stock buyback is the practice where companies decide to purchase their own share from their existing shareholders either through a tender offer or through an open market. In such a situation, the price of concerning shares is higher than the prevailing market price. When companies decide to opt for the open market mechanism to repurchase shares, they can do so through the secondary market. On the other hand, those who choose the tender offer can avail the same by submitting or tendering a portion of their shares within a given period. Alternatively, it can be looked at as a means to reward existing shareholders other than offering timely dividends. What Is a Buyback? A buyback is a company’s purchase of its outstanding stock shares. Buybacks reduce the number of shares available on the open market. Companies usually buy back shares of their stock to increase the value of the remaining shares by reducing the supply of them. They may also buy back shares to prevent a major shareholder from taking a controlling stake in the company. Reasons for Share Buyback When There Is Excess Cash But Not Enough Projects To Invest In- Companies issue shares to raise equity capital and expand their venture, but often such a practice does not prove to be of much use. Similarly, keeping excess money at the bank is more like a truncated cash flow offering liquidity over the ideal requirement. Hence, instead of piling on cash reserves, companies with robust financial standing tend to make the best possible use of the cash available through a stock buyback. It is a Tax-effective Rewarding Option- When compared to dividends, share buybacks are more tax-effective for both companies and their shareholders. To elaborate, stock buybacks are subjected only to DDT, and the amount of money is deducted before distributing the earnings to the surrendering shareholders. On the other hand, dividends are taxed at 3 different levels. To Consolidate Hold Over the Company- Often when the number of shareholders of a company exceeds the manageable limit, it becomes challenging for the entity to reach a decision unanimously. Additionally, it may result in a power struggle within the company and among the shareholders with voting rights. To avoid or aggravate such situations, company board members often resort to share buybacks and plan to consolidate their hold over the company by increasing their voting rights. To Signal that the Stock Is Undervalued- When a company decides to buy back its shares, it may also indicate that the company considers its shares to be undervalued. Besides serving as a remedy for the situation, it also helps to project a positive picture of the company’s prospects and its current valuation. Other than these, stock buybacks may be prompted to improve companies’ overall valuation or to reward their existing shareholders. What Does Share Buyback Signify Investors often believe that the declaration of upcoming buyback of shares signifies that the company’s prospect is profitable. Further, it is believed to influence the overall stock price of the company. For instance, investors often believe that repurchasing shares from shareholders is a probable indication of the acquisition of big companies, the launch of new and improved product lines, etc., among others. All in all, it can be said that share buyback signifies that the stock valuation of a company is going to increase shortly. Notably, hinting at such positive prospects further helps to draw the attention of investors who wish to make the most of such favorable circumstances. Regardless, certain companies may resort to this practice when their stock valuation decreases. It is mainly done to prevent their capital from eroding further. As a means to identify the actual motive behind the stock buyback, investors should factor in a few things, like the current trends in stock prices and current earnings per share. Additionally, it will help them understand the implications of such a decision. Difference Between Dividend and Share Buyback Though share buybacks and dividends are different ways of rewarding a company’s shareholders, their significance is entirely different. To understand the concept better, individuals need to become familiar with the difference between the two and their underlying purpose. To elaborate, the pointers below highlight the differences between Dividend vs Share Buyback- Dividends are earnings that are allocated to all the existing shareholders of a company. On the other hand, existing shareholders who decide to surrender a portion of their shares would benefit from share buybacks. When a company decides to offer a dividend to its shareholders, the total number of shares does not undergo any change. Conversely, for share buybacks, the total number of outstanding shares undergoes a reduction. In terms of regularity and payout frequency, most companies prefer to reward their shareholders by offering dividends. Comparatively, the practice of stock buyback is new in India and a rare occurrence. Typically, companies tend to declare a reward in the form of a regular, annual, special, or one-time dividend. However, when it comes to share buyback meaning, there is no variation or type of it. Tax on Buyback of Shares – Both dividends and share buybacks are subject to different tax treatments. To elaborate, in the case of dividends, there is a three-way tax implication. First, it is paid out from the net profit of the company, wherein, the tax has already been paid. Next, a Dividend Distribution Tax or DDT of at least 15% has to be paid by the company declaring dividends during profit allocation. Lastly, shareholders with an accrued dividend of over Rs. 10 Lakh would be liable to pay Additional Dividend Tax at the rate of 10%. Previously, share buybacks were treated as capital gains and hence, were subjected to capital gain tax. However, post-July , investors are not required to pay such a tax on their earnings through a stock buyback. Conversely, the share buyback declaring companies are entitled to deduct 20% of the generated profits as DDT before disbursing them to the shareholders. The table below highlights the fundamental differences between dividends and stock buybacks – Point of Difference  Dividend  Share Buybacks Beneficiary Existing shareholders.