Buyback
Also written Share buyback · Buy-back · Share repurchase
A company purchasing its own shares out of reserves and extinguishing them, reducing share capital and raising earnings per share for the shareholders who remain.
In plain language
A buyback is a company spending its own cash to buy its own shares back from shareholders and then cancelling them.
The shares cease to exist. The same profit is afterwards divided among fewer shares, so earnings per share rises without the business earning a rupee more. It is a way of returning surplus cash to shareholders, and an alternative to paying a dividend.
How it works
Two routes are used in India:
- Tender offer — the company offers to buy a fixed number of shares at a fixed price, usually above market, and shareholders accept or decline. If more is tendered than offered, acceptance is proportionate.
- Open market purchase — the company buys through the exchange over a period at prevailing prices.
The cash comes from free reserves, the securities premium account or the proceeds of a fresh issue — never from the proceeds of an earlier issue of the same kind of shares. Bought-back shares are extinguished, not held in treasury.
A buyback is a signal as much as a transaction. Management is saying the share is worth more than its price. That signal is only credible if it is true.
A worked example
A software company has:
- Profit after tax: Rs 1,800 crore
- Shares outstanding: 60 crore
- EPS: Rs 30.00
- Share price: Rs 750 (P/E of 25)
- Surplus cash: Rs 3,000 crore
It buys back 3 crore shares at Rs 900 — a 20% premium — spending Rs 2,700 crore.
After the buyback:
- Shares outstanding: 57 crore
- EPS = 1,800 ÷ 57 = Rs 31.58, up 5.3%
- At an unchanged P/E of 25, the share is worth Rs 789
Every remaining shareholder now owns a slightly larger slice of the same company. Note what did not happen: profit did not rise, and Rs 2,700 crore of cash left the balance sheet, so book value per share falls even as EPS rises.
Why NISM asks about it
Chapter 9 (Corporate Actions) covers buybacks alongside bonus issues, splits and dividends. The examinable distinction is what each action does to share count, EPS, book value and the shareholder's proportionate holding.
Common exam traps
- A buyback reduces share capital; a bonus issue increases it. Both change EPS, in opposite directions, and neither changes the underlying business.
- Bought-back shares are extinguished. Indian companies do not hold them as treasury stock for later resale.
- A buyback raises EPS and ROE while reducing net worth — which makes ROE look better for a reason that has nothing to do with operations.
- A buyback funded by borrowing returns cash to shareholders while increasing financial risk. Read the source of funds, not just the announcement.
- A shareholder who does not tender still benefits, through a larger proportionate stake.
Check yourself
1.What is the effect of a buyback on EPS and per-share market value, assuming no change in profits?
- a)Both fall, as with a bonus issue
- b)EPS rises because outstanding shares reduce, and market value per share goes up as the same value is spread over a smaller lot
- c)EPS is unchanged; only the share count falls
- d)EPS rises but market value per share falls
Show the answer
Answer: (b) EPS rises because outstanding shares reduce, and market value per share goes up as the same value is spread over a smaller lot
As buyback of shares result in the reduction of outstanding shares, even if there is no change in the P/L, it would result in increased EPS for post buy back shareholders. These shareholders may also enjoy higher dividend on each of their shares.
Assuming the market value of shares based on earnings remains same pre and post buyback, as it is to be spread over smaller lot now, market value per share goes up.
Option A confuses a buyback with a bonus, and the contrast is the important one. A bonus is a book entry with no economic impact, where per share data witnesses immediate deterioration but ownership value is unchanged. A buyback moves real cash out of the company and cancels shares permanently — the shares bought back are extinguished by the company within stipulated time frame and that leads to a reduction in its share capital.
The funding constraint: buyback of shares can be done only out of the reserves and surplus available with the company.
The eligibility bar: the company should not have defaulted on its payment of interest or principal on debentures/fixed deposits/any other borrowings, redemption of preference shares or payment of dividend declared.
The four routes: the tender method by making an offer to existing shareholders on a proportionate basis or from the open market through a book building process or through the stock exchange or from odd lot holders.
And the approval needed: the company needs to pass a special resolution specifying the timeframe for buy back and maximum price.
2.Which reserves may NOT be used for a bonus issue?
- a)Free reserves built from genuine profits
- b)Reserves built from revaluation of assets
- c)The general reserve
- d)Retained earnings of prior years
Show the answer
Answer: (b) Reserves built from revaluation of assets
The company makes the bonus issue out of its free reserves built from genuine profits. Reserves built from revaluation of assets are not allowed to be considered for making a bonus issue.
The logic is that a revaluation reserve represents an unrealised paper gain from marking an asset up — no profit has actually been earned, so capitalising it would create share capital out of nothing.
A second restriction sits alongside: a company cannot make bonus issue if it has defaulted on payment of interest and/or principal on any debt security issued or any fixed deposit raised.
That restriction has a close parallel in the buyback rules: to be eligible for a share buyback, a company should not have defaulted on its payment of interest or principal on debentures/fixed deposits/any other borrowings, redemption of preference shares or payment of dividend declared.
In both cases the principle is the same — a company cannot make distributions to shareholders while it is failing its lenders.
And what the bonus does to reported numbers: as total number of shares go up without any economic change in the profit and loss statement or balance sheet, per share data (earning per share, book value per share, market price per share etc.) witnesses immediate deterioration.
Where this is taught
- Series XV · Chapter 9: Corporate Actionsintroduced here
- Series II-B · Chapter 2: Characteristic of Equitiesintroduced here
Related terms
- Diluted EPSEarnings per share recalculated as if every instrument that can convert into equity had already converted — the pessimistic, and usually the more honest, share count.
- Dividend Payout RatioDividend per share divided by earnings per share.
- Return on EquityProfit after tax as a percentage of shareholders' net worth — what the company earned on the money its owners have left in it.
- Stock splitA reduction of face value in a defined ratio, increasing the number of shares proportionately.
- Reverse book buildingThe bidding process by which the exit price in a voluntary delisting is discovered from public shareholders above a fixed floor price, instead of being set by the acquirer.
- Paid-up capitalThe part of the issued capital that shareholders have actually paid for — issued capital less the calls still outstanding on partly paid shares.