Buyback of shares are a common way of dealing with purchases by companies across the world. In India, many investors are not clear about how share buyback actually takes place. With companies slowly adopting this route an increasing number investors will be subject to share buyback and they need to be clear about the operation of this mode. Here are some pointers that will help them in that direction.
The entire process of buyback of shares consists of a situation where the company buys its own shares back from the public and then extinguishes the shares. The process of buying back the shares is vital because it involves a position where the company itself acquires the shares because they feel it is undervalued and the investors reduce their holding in the company. In a case where the shares are not kept alive then there is a reduction in the number of shares in the company.
Methods of buyback
There are two ways in which a buyback is conducted and based on this the individual will know the route to be adopted by them for completing the process. On one hand there is the direct market mop up wherein the company fixes a price till which it buys back the shares. Then whenever it spots the market price lower than the limit it will buy the shares from investors in the market itself. For an investor they will not know who is at the other end of the transaction and here they sell the shares like in the normal course of investing without knowing who they are selling to.
The second is the direct method of buyback where the company buys shares directly from the investor at a fixed price. The investors know that they are selling the shares to the company and hence they need to transact this in a slightly different way. This will require an off market transaction for the transfer to the account of the company.
The buyback has an impact on several areas. The most important among them is that several ratios will be affected. If the shares are cancelled then the number of shares outstanding will go down and with earnings being maintained or raised it can lead to better earnings per share. Similarly this can lead to several return ratios looking better because of the reduced capital base leading to a better valuation for the company as a whole.
The author is a certified financial planner