Buyback is a corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than market price.
Warren Buffett alluded to the share buybacks in his 1984 letter to shareholders: “When companies with outstanding businesses and comfortable financial positions find their shares selling far
below their intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.”
While a share buyback does not impact a company’s business, there is a financial impact to the extent that the cash and the number of shares in its books reduce. As a result, the EPS (earnings per share) goes up. Since buyback reduces outstanding shares, it boosts earnings per share and, therefore, the share price. In tender offer, the company makes an offer to buy a certain number of shares at a specific price directly from shareholders.
Buybacks improve return ratios of companies as they shrink the equity capital base and improve earnings per share.
Berkshire Hathaway has not paid dividends since 1960, but it maintains an aggressive stock buyback policy that puts cash directly into shareholders’ pockets. Berkshire shareholders often receive as much as 120% of the market value for shares they wish to sell back to the company.
In India also, buybacks are becoming attractive for companies. Considering the three levels of taxation — corporate tax, dividend distribution tax by companies, and 10% tax on dividend in excess of Rs 10 lakh in the hands of the recipients :Companies are likely to cut down on dividend distribution and opt for share buybacks as it is more efficient way of use of money.
A buyback has another effect if the shares are not valued correctly. If the company is worth 100 per share but for some reason the share price is down to 50, then after the buyback the value per share has even gone up. Basically the company buys from stupid investors, which increases the value for clever investors holding on to their shares.
All in all, to summarize, keep eye on companies who are on continuous buy back spree… You may probably get your next multibagger out of it…