Annually, listed companies need to seek their shareholders' agreement to renew their authority to buy-back their shares from the market. This authority can be considered as an additional option for the company to use its surplus financial resources.
All things contain both positive and negative effects. Thus, in this post, I am going to summarise the advantages and disadvantages of this financial tool in the following aspects.
The effect is mainly dependent on the price of buy-back.
If our company buy-backs the shares when the market price of company is lower than its Net Assets per share, then the Net Assets per share will be increased once the purchased shares are cancelled.
Net Assets = $200
Share number = 100
Net Assets per share = $2
If 10 shares are bought back with market price of $1 and are cancelled, then share number remains 90. Consequently, Net Assets per share becomes ($200-$10)/90 = $2.11
Of course, capital gain due to "buy low, sell high" will increased the Net Assets in terms of one-off profit, and vice versa.
While the cash in the company was used to purchase its own shares, the amount of cash would be decreased.
This should have insignificant negative impact if the company already reserves sufficient fund for this business operation and the market price is undervalued.
Nonetheless, the reduction of cash may cause the company forgo feasible investment opportunities that may emerge in the future; and reduce the amount of resources available for distribution to its shareholders.
Earnings per shares
If the company does not have better option to use its cash, the option of share buy-back can be treated as an investment to optimise its cash.
The Volatility of the shares
Share buy-back option allows a company to stabilise the supply and demand of its shares.
- EPS - If the purchased shares are cancelled, the EPS will be improved and shareholders are likely to enjoy an increase in the value of their investment in the company.
- Higher Dividend - The reduction of share capital may increase the likelihood of a higher dividend rate being declared in the future.
- Share Dividend - The purchased shares will provide options to the shares for capital gain and to distribute the shares to shareholders as a reward in terms of share dividend.
- To take preventive measures against speculation particularly when the shares are undervalued
- To stabilise the company's market price and consequently enhancing investors' confidence;
- Capital Gain - by selling the Purchased Shares with higher price.
- Reduce the financial reserves that may be available for distribution to the shareholders in the foreseeable future.
- Result opportunity costs as better investment opportunities may be foregone in the future due to insufficient financial resources upon implementing the Share Buy-Back.
- Deprive the interest income that can be derived from the funds used for the Share Buy-Back.
Normally, the Share Buy-Back will be exercised only after in-dept consideration of the financial resources of the business and will be balanced against investment opportunities and other proposals that can enhance the value of the business. Thus, Share Buy-Back generally is not expected to have any potential material disadvantages to the business and its shareholders. That's all for today. I hope this post provides some helpful insights about share buy-back option for you. More fascinating articles and sharing will be updated weekly in Xaivier Blog. So, you are welcome to subscribe our feed to receive our weekly updates.
Written by: Xaivier Chia
P/S: The above sharing is solely based on personal insight and information that believed to be reliable. Your valuable feedback are very welcome.