Generally, companies buy back their shares when they perceive their own shares to be undervalued or when they have surplus cash for which there is no ready capital investment need. For example, Essar Oil, Reliance, Siemens and Infosys are some examples of companies that have bought back their shares. Share buybacks also prevent dilution of earnings. In other words, a buyback enhances the earnings per share, or conversely, it can prevent an EPS dilution that may be caused by exercises of stock option grants etc
Purpose of Share Buybacks
Companies making profits typically have two uses for those profits. Firstly, some part of profits are usually repaid to shareholders in the form of dividends. The remainder, termed stockholder’s equity, are retained within the company and used for investing in the future of the company. If companies can reinvest most of their retained earnings profitably, then they may do so. However, sometimes companies may find that some or all of their retained earnings cannot be reinvested to produce acceptable returns.
Share repurchases are one possible use of leftover retained profits. When a company repurchases its own shares, it reduces the number of shares held by the public. The reduction of the float, or publicly traded shares, means that even if profits remain the same, the earnings per share increase. So, repurchasing shares, particularly when a company’s share price is perceived as undervalued or depressed, may result in a strong return on investment.
One reason why companies may prefer to keep a substantial portion of earnings rather than distribute them to shareholders, even if they aren’t able to reinvest them all profitably, is that it is considered very embarrassing for companies to be forced to cut dividends. Normally, investors have more adverse reaction in dividend cut than postponing or even abandoning the share buyback program. So, rather than pay out larger dividends during periods of excess...
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