Generally, it has been a notion that when a company’s management thinks that the stock is undervalued, or when the sentiment on their stock is low, they prefer to initiate stock repurchase program. This is one of the strategies which could also boost shareholder confidence and represents another way of returning value to shareholders by buying back the stock. Shareholders get market value plus premium and management gets to pull shares out of circulation, thereby increasing the value of the remaining shares by reducing supply. Typically, stock buybacks allow companies to reinvest in themselves by reducing the number of outstanding shares on the market.
When companies reach a position where they are generating more cash than required for reinvestment in business, companies can return wealth to shareholders through these stock buybacks. As corporates are becoming more flexible and progressive, instead of traditional dividend payments, buybacks have been viewed as a flexible practice of returning excess cash flow. It may seem to be the best way to return the money back to shareholders. It has been said that the repurchase only makes sense if the shares are bought at a price below intrinsic value, when that rule is followed, the remaining shares experience an immediate gain in intrinsic value.
Many investors prefer buybacks at the back of the choice they have for participating in the repurchase program. Investors can in a way, defer taxes and turn their shares into future gains by not participating in a share buyback. From financial perspective, buybacks benefit investors by improving shareholder value, increasing share prices and creating tax beneficial opportunities. The reduction in total number of shares ultimately increases EPS. Then, lower supply of shares in the market results in upward demand for shares boosting the share prices, as indicated above. Shareholders can defer capital gains if share price increases in the case of a repurchase of a company stock. Further, lower capital gain tax rates levy if a stock has been held for more than a year while dividends are chargeable at ordinary income tax. Thus, when a company announces a share buyback, it comforts the investors that the company has excess cash on hand, and shareholders need not then worry about cash flow problems. This supports the price of the stock as well as provides long-term security to investors.
On the flip side, buyback strategy may also be adopted to artificially boost share prices. This might benefit the short-term investors while long-term investors might lose out as it may misleadingly indicate that earnings are improving due to organic growth. Another key thing to note is the timing of the buybacks, and whether the buybacks are trotted out at the wrong time in the company’s cycle in terms of the stock value.
Insurance giant QBE Insurance Group Ltd (ASX: QBE) has recently announced a $1 billion share buyback offer while the full year result entailed 4% rise in revenues and 5% rise in net profit after tax. This decision has been rejoiced by many shareholders as the offer extends through the next three years. Other companies who have recently announced for buybacks include Coca-Cola, Charter Hall Retail, and Sirtex.
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