Whenever you buy shares in the company, you expect two things — first, capital appreciation in the form of an increase in the price of a share — secondly, dividends which is a part of the profit that the company will share with you. A company always strives to maintain steady cash dividends. It will only increase dividends if it feels that the earnings in the future will grow. If they have generated tremendous profits but do not believe that the company will sustain it, they will pay higher dividends. Instead, they will use a technique called Share Repurchase or Share Buyback.
As the name suggests, share buyback is when the company buys back their shares from the public at a higher price. This premium is the shareholders’ return, which is nothing but capital gain.
Now you might wonder why the company will buy back its share at a higher price? A company reporting high profits has excess cash. They have to share it with shareholders in some way or the other. If they choose to pay dividends, the expectations of shareholders will increase. But to avoid this commitment, a company can choose to buy back its share. Being a one-time event, share repurchase will not raise expectations of the public for the future. And they are a positive signal for the company. It gives the impression that the company is buying its shares because it believes the value will increase. Whenever a share buyback is announced, the stock price always seems to increase.
If a company wants big institutional investors to invest in it, it will take its shares back from the public and give them to big investors at a much higher price.
Apart from the benefits to the company, share repurchase is favoured among shareholders as well. The reason is the tax advantage. Dividends are subject to double taxation. The first tax is deducted at the corporate level and then at the shareholder level. But in the case of share repurchase, you have to pay only capital gain tax. Over the years, many companies worldwide have adopted share repurchase instead of paying regular cash dividends. Tesla has never paid any dividends but has done share buybacks. Recently Infosys has announced share buybacks. So if such profitable companies are taking this route, it is not such a bad thing after all.
Concept: Shivangi Bhatia
Editor: Minakshi Todi