Buy-back of Securities

The share market is quite unpredictable and a risky venture. It could gain you substantial profits, and it could also lose all your money. However, the prospect of such quick money is fascinating to many of us, and hence, the share market is an evergreen investment industry. A company puts its shares out in the market for sale. Anyone can purchase these shares, and the company can get the required investment. However, under certain circumstances and for some purposes, a company repurchases its shares back from the market. Let us learn how the buy-back of securities works.

What is a Buy-back of Securities?

Investment in share markets comes with a substantial amount of risk. Sometimes the share you buy could earn you five times the invested amount. Sometimes you purchase the shares of a company because it’s performing well, but then its price may start taking a hit. The stock market is a gamble.

Companies may try to amend such situations and ensure their shareholders don’t suffer huge losses. Buy-back of securities or share repurchase is one such method.

In a buy-back of securities, companies purchase their shares from the current shareholders, ensuring they gain profit in the form of cash. 

However, a company may buy back its shares for various other reasons. Let’s take a look at these considerations.

Buy-back of Securities: Meaning and its Purpose

When a company attempts to repurchase the securities it has already sold to the public for several possible reasons, it is called a buy-back. Apart from shareholder profit, here are the other bases for a company repurchasing its shares.

Increasing share prices 

When a company buys back its share from a market, the total number of shares available in the market decreases. This measure is usually taken when a company feels undervalued in its share prices.

With shares being taken out of circulation, their supply decreases, and the law of the market comes into play: when a commodity becomes rare, more people seek to buy it, and the price increases. We see a hike in the price of the remaining shares. So even though the total profit remains the same, the earnings per stock of the company increase.

Investment in itself

Buy-back of securities by a company can also be a way for the company to invest in itself. When they purchase their shares, they become their investors. This could prove to be profitable.

Returning surplus cash to shareholders

This is like a bonus or reward to the current shareholders. When the company has surplus cash, it could let its shareholders avail of its benefits too. The companies buy back their shares from the market, and the shareholders profit from this. 

Exit route to shareholders

The stock prices of a previously great company could begin to collapse, and a great number of enthusiast buyers could suffer losses. Therefore, when a company’s shares are thinly traded, undervalued, or falling in price, the companies offer an exit route to the shareholders.

Companies purchase their shares back from the shareholders, which release them, and they get money in return. This might not always be profitable.

Increase in return of capital

A company could achieve the following objectives via a buy-back of securities.

• The return-on-investment rate for the company increases
• The return on the net worth of the company also improves
• The long-term shareholder value for the company grows

An Example of a Buy-back of Securities 

Suppose a company named A has performed exceptionally well financially throughout the year. However, this doesn’t reflect in the company’s stock price. The company’s stock has underperformed the stock prices of its rival company B.

So, even though company A has profited financially, its shareholders received no part of the profits. In such a case, company A buys back around 10% of its shares from the market. It rewards the shareholders from whom these shares have been purchased.

As the number of stocks in the market decreases, the price of the rest of the stocks also rises. Hence, the remaining shareholders also profit from this.

How a Buy-back of Securities Works

The buy-back of securities works in the following way.

• A tender offer can be made to the company at a premium over the current market price of the stock
• The shareholders can return all of their stocks or a fraction of their stocks to the company
• The company buys back these shares in multiple lots. It may do this in short breaks or over a long period
• The company funds its buy-back of securities through cash in hand, debts, or through finance from other operations

Such is the buy-back on securities concept.

Conclusion

The instability of share markets leads to many ideas to counter the upheavals. The buy-back of securities is one such strategy. In the buy-back of securities, the company purchases its shares back from the market at market price or with a little premium on the market price.

The purpose of such buy-back of securities could be many. This helps the company to gain more profits per stock. The company also gets more return in investment through buy-back of securities. For customers, it’s an easy way to get rid of the stocks of companies if they are not performing well. They also avoid loss through this.