Why company buy back shares? The reason behind this question is that the companies have lots of cash, which is termed as surplus cash. When a company purchases its own shares and cancels them off, it is termed as buy-back shares.
Reasons Why Company Buy Back Shares
When the company has surplus cash they either pay high dividends to their shareholders or invest in government securities shares.
They become debentures of other companies and try to earn income from it.
The third option that the company has, is to acquire other companies from the cash they have.
And the last option the company has, using the cash to buy back shares. Buying back shares is a better option rather than paying high dividends to the shareholders.
Why not just cancel the shares and get a reasonable alternative?
The company cannot just go on acquiring other companies. According to the report, most of the Indian companies got bankrupt just because of bad acquisitions.
Objectives of buying back shares
To increase earning per share, i.e. EPS
If there is an increment in earning per share, then the company can buy back shares. EPS is calculated as earnings divided by several shares.
So if this strategy is implemented, the earning will remain the same and the number of shares will get decreased. As in buy back shares, the shares which were bought back will eventually get cancel so, the number of shares in issue will get reduced.
Let’s have an example here:
If the company have 10 lakh as earning, it will remain the same as 10 lakh even after buy back but the number of shares will get reduced.
Let’s say 11 lakh, where the number of shares before they buyback. After the buyback, let’s say 3 lakh shares were bought back. So now 8 lakh is outstanding here. The EPS figure will increase if the company buy back share and hence there will be profit for sure.
To increase promoters holding
Now, when the shares are bought back those are of the third party, the company is buying out third-party shares, and then immediately the promoters’ holding will be increased. And that’s the advantage.
To support the share price
Whenever the company go for buyback of share, it is seen practically that the share in the stock exchange market gets automatically increased.
To pay surplus cash to shareholders
If the company have surplus cash then this surplus cash is paid to the equity shareholders or the preferential shareholder. This will again gain an enormous advantage.
Final words
This is why company buy back shares. As we have seen the advantages, if the company buy back shares it may hold a better place as well as there won’t be any penalty. Analyze and inculcate it in a better way.