Share buyback refers to the process in which a company decides to repurchase its own shares from existing shareholders. This can be done through either a tender offer, where shareholders are invited to sell their shares at a specified price within a certain time frame, or through an open market purchase, where the company buys shares at the prevailing market rate.

Typically, companies offer to buy back their shares at a price higher than the current market value, providing an attractive option for shareholders to sell. Buybacks are often seen as a strategy for companies to reduce the number of outstanding shares, increase shareholder value, or signal confidence in their own future performance.

Methods of Share Buyback

Tender Offer: In a tender offer, the company offers to repurchase its shares at a specified price, known as the offer price, allowing shareholders to tender or sell their shares. Once the transaction is completed, the proceeds are credited to the shareholders’ primary bank accounts.

Open-Market Offer: In an open-market offer the company buys back its shares by actively purchasing them from sellers on the stock exchange. The buyback period, specified in the buyback offer, can extend over several months. Once the shares are sold, the proceeds are credited to the shareholders’ trading accounts.

Why Do Companies Buy Back Shares?

Returns for Shareholders: Share buybacks offer companies an alternative method to return capital to shareholders without the need to distribute dividends. For businesses with surplus cash that lacks other profitable avenues for investment, buybacks can be a strategic option. It is also a more tax-efficient way to return value to shareholders compared to dividends.

Indicate Stock Undervaluation: When a company undertakes a share buyback at a price higher than the current market value, it sends a strong signal to investors that management believes the stock is undervalued. This move can boost investor confidence, often leading to a rise in the share price as the market begins to align with the company's belief in its own potential.

Reduce Outstanding Shares: Share buybacks can also serve as a defensive mechanism, making the company more resistant to hostile takeovers. With fewer shares available on the market, any acquisition attempt by another company would become more costly, thus reducing the likelihood of a takeover. Fewer outstanding shares mean greater control remains within the company or among loyal shareholders.

Enhance Financial Metrics: One of the direct benefits of a share buyback is the reduction in the number of outstanding shares. With fewer shares on the market, the company's earnings are divided among a smaller pool of shareholders, leading to an increase in earnings per share (EPS). This can be an attractive outcome for investors, as higher EPS often indicates a company's stronger profitability. Certain financial ratios, such as return on equity (ROE) and debt-to-equity ratio, can also be positively affected by share buybacks. By reducing the number of outstanding shares, companies can enhance their ROE, as the earnings are spread across fewer shares. Additionally, this can improve the company’s debt-to-equity ratio, presenting a more appealing financial picture to investors and creditors, and potentially making it easier for the company to secure future investments or loans.

What Does A Company Do After Share Repurchase?

Share buybacks can greatly influence how investors evaluate a company's worth. When a company buys back its shares, it may choose to either cancel them, permanently decrease the total number of outstanding shares, or retain them as treasury shares, which are excluded from the share count. This has a direct effect on key financial metrics.

Disclaimer: This content was partially produced with the help of Benzinga Neuro and was reviewed and published by Benzinga editors.