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Why do companies buyback their shares?
Share buyback is the process by which a company repurchases its own shares from the investors. It results in a decrease in the total number of outstanding shares which in turn increases the value of shares.
Companies may tend to buy shares back for a host of reasons. Some of the reasons for share buyback are as follows −
Too Much Cash with Very Few Investment Opportunities
Mature companies that have with too much cash on their books but too few opportunities to invest money can resort to share buyback in order to increase the value of shares. The expense in the form of buyback offers the companies the opportunity to have more ownership and control over their shares. This is a favorable offer for companies that may not have opportunities where they may invest money to start new investment projects.
To Offer Tax-effective Benefits to Shareholders
The Government of India levied 10% tax for shareholders getting dividends worth more than 1 million a year. This law was meant to tax the wealthy shareholders who have a significant number of shares of mature companies. To dilute the effect of this taxable income, share buyback by the company is an effective step.
Increase in Company Valuation
Share buybacks improve the bottom-line of companies by increasing the authority of the company having more ownership. This indirectly increases the valuation of the company.
When a company buys a significant number of shares, it reduces the overall number of outstanding shares in the market. However, the value of shares does not fall due to buyback. Since the net earnings remain the same, the valuation of shares goes up. This increases the valuation of the company.
A Hint that the Stocks are Undervalued
Buyback of shares may be a hint that the stocks are undervalued. When a company buys its own shares, it may be due to the lack of a bottom value of a share. By buying its own shares, companies can improve the valuation of the shares. In most cases, share buybacks offer a bottom-line to shares that are undervalued in the markets.
More Cash to Shareholders
Shareholders can be offered more cash after the buyback of shares by a company because its reserves go up when they buy shares back. This is usually done to offer more money to shareholders and keep them satisfied in terms of income from their investments.
Help Promoters to Consolidate Their Stake
Share buyback helps promoters of a company to consolidate their overall stake in the company. When the promoters feel that their stake in the company has gone down a certain level, they may sell their stake or wait for buyback of shares that makes their stake go up above the desired levels. This is usually the most applicable case when a company is going to be taken over by another company.
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