Own shares purchase, also known as share buyback or stock repurchase, is a financial strategy employed by companies to buy back their own shares from the market. In this comprehensive guide, we will explore what own shares purchase entails, its implications, and why companies engage in this practice.
Key Points about Own Shares Purchase
- Definition: Own shares purchase refers to the process whereby a company buys back its own outstanding shares from the open market. This means that the company becomes its own shareholder by holding a portion of its own stock.
- Motivation:
- Undervaluation: Companies often repurchase their own shares when they believe that the current market price does not reflect the true intrinsic value of the stock.
- Capital Allocation: It’s a way for companies to allocate excess cash effectively, as they can reinvest in their own business rather than distributing dividends or making acquisitions.
- Boosting EPS: By reducing the number of outstanding shares, companies can increase earnings per share (EPS), which may make the stock more attractive to investors.
- Signal to Investors: Share buybacks can be seen as a positive signal to investors, indicating that the company believes in its future prospects and considers its own stock to be undervalued.
- Methods of Own Shares Purchase:
- Open Market Purchases: Companies buy back shares through regular transactions on the open market, just like any other investor.
- Tender Offers: Companies may offer to buy back shares directly from shareholders at a specified price within a certain timeframe.
- Accelerated Share Repurchase (ASR): In ASR, a company buys back shares from an investment bank, which then delivers shares to the company over time.
- Implications:
- Impact on Stock Price: Own shares purchase can lead to an increase in stock price due to the reduction in the supply of shares.
- Ownership Structure: It may change the ownership structure of the company, potentially consolidating control in the hands of existing shareholders or management.
- Financial Health: Share buybacks can signal financial health, but they can also be detrimental if the company overpays for its own shares or does so with borrowed funds.
- Dividend Policy: Companies may use own shares purchase as an alternative to paying dividends, which can affect the dividend policy.
- Example:
- Suppose XYZ Corporation has 1,000,000 outstanding shares trading at $50 per share. The company decides to repurchase 100,000 shares at the current market price.
- After the buyback, the total number of outstanding shares reduces to 900,000, leading to an increase in EPS as earnings are spread over fewer shares.
- Reference:
- “Financial Management: Theory & Practice” by Eugene F. Brigham and Michael C. Ehrhardt. Link
Conclusion
Own shares purchase is a strategic financial maneuver utilized by companies to enhance shareholder value, signal confidence in their business, and efficiently allocate capital. By understanding the motivations, methods, and implications of share buybacks, investors and analysts can better interpret company actions and make informed decisions regarding their investments. While own shares purchase can be a powerful tool in capital management, it is essential for companies to execute it judiciously and transparently to maximize its benefits and avoid potential pitfalls.