With cash, companies buy back shares that they previously issued to the market. This is a method used to repurchase shares. It can be done for a variety of reasons, not just because a stock has been undervalued.
If companies have additional cash, no specific investments or needs, they may consider buybacks. The share count is reduced, which means that earnings per share (or EPS) are lower for shareholders. This also boosts equity returns.
Many companies buy back shares from Indian shareholders through direct buyback. This method involves the company buying shares from large shareholders by negotiating share prices. While a company may buy back shares from shareholders, there are many other options for buying back shares in India. These are the other options:
Individual shareholders can also buy shares back. Open market is one way to buy back shares. Because of the large number of shares bought, the shares buyback takes place over a long period. The company has the option to cancel the repurchase program at any time.
The tender is the method by which Indian companies buy back shares. Shareholders can submit their shares to the company to be sold. The company sets the price and it is higher than the current market price. Tender offers are usually for a limited time and generally last only a few days.
This works in the same way as the fixed-price tender except that instead of allocating a fixed price, the company offers a range of prices for shareholders to choose from. The stock's minimum price is greater than the current market price.
Companies use the open market and fixed-price tender more.
Buybacks of shares may be a sign that stock is undervalued, as we mentioned previously. To increase earnings per share or the price of shares, companies buy back shares they have previously issued.
The other reason shares buyback exists is to prevent any mergers or takeovers. If another firm plans to purchase a majority of the shares on the market, the company can purchase back its shares and regain ownership.
Capital gains taxes are applicable to shares bought back. This method is more tax efficient than dividends. Dividends are specific amounts per shares that are paid to shareholders. Dividends are paid to all shareholders, while the option to buy back shares is available only to those who have chosen it. Dividend distribution tax (or DDT) is a tax that companies must pay to the government before they can distribute profits. If the dividend income exceeds Rs 10 lakh, shareholders will have to pay additional tax.
The rate of tax on shares bought back depends on how long they have been held. Shareholders who give up shares to buyback after one year would be subject to 10% tax on earnings. Short term capital gains that are made before one year are subject to 15% tax. Share buybacks might be a better option for the company.
Companies can use their free reserves to buy back shares. One such account is the capital redemption reserve account, which is managed by a company. This account is for redeemable shares. The capital redemption reserve would be credited with the share nominal value if a company purchases back shares from the free reserves.
Securities premium account - This is another method of buying back shares. This is money added to a company's net profit when it sells shares at more than their fair value.
To repurchase equity shares, companies cannot use any proceeds from equity share issuance. To purchase equity shares, companies can use preference shares and proceeds from debenture issuances.
There are three options for buying back shares: direct negotiations with large shareholders, open market, fixed-price tender offer, and Dutch auction tender offer. Flexibility is the greatest advantage of buying back shares. The flexibility of the process allows shareholders to choose whether they want to sell back their shares or not. Companies can also decide whether or not to take up or cancel any repurchases. Other benefits include tax savings and the signaling opportunity that it offers companies. To make informed decisions, shareholders need to understand the reasons behind buybacks and determine if they are right for them.