When a company issues shares to the public, it raises its capital and allots shares to the shareholders. Buyback is exactly opposite to this. In Buyback, the company purchases its own shares from the shareholders and pays them the money.
Advantages to the retail investors:
Increase in the wealth of the retail investor:
Whenever a company announces buy back, it is generally done at a price higher than the market price of the shares. Hence, buyback is profitable from the view point of a retail investor. Also, for an already existing investor, buy back will be more beneficial because as the company announces buyback, it is generally perceived as a good sign and hence there is a renewed buying in the share. This causes the price of the share to increase and hence it increases the wealth of the investor.
However, there are few things which must be kept in mind before giving your shares to the company for buyback.
- What is the % of the shares the company is willing to buy back? This matters the most because not all the shares held by the investor will be bought back by the company. Hence, the acceptance ratio matters a lot. If the ratio is low, then it would be prudent not to invest in the share only to get the benefit of buyback. Hence, the buyback will not be attractive option for a new investor who is thinking of purchasing the share after the company announces buyback if the acceptance ratio is low. But, for an existing old investor, who already holds the shares, the buy back announcement may be beneficial as he is already holding the shares because the company will be buying the shares at a price which is higher than the market price.
- What is the price of the buy back? If the buyback price is less attractive, then again it won’t be prudent to invest in the shares with the greed of buyback by the company. Les attractive here would mean that the existing market price and the price of buy back are not having much difference.