The stock market is abuzz with excitement as Infosys announces a massive share buyback worth Rs. 18,000 crores, covering about 2.41% of its shares. Unsurprisingly, this move has sparked a wave of optimism among investors, sending the stock price higher. So what exactly is a share buyback? Why do companies spend thousands of crores to purchase their own shares from the market? And most importantly, what does it mean for you as an investor? Get answers to all these questions and more in this blog to know why share buybacks are an important tool in the corporate world that can shape both company strategy and shareholder wealth.
A share buyback (also called a share repurchase) is when a company decides to purchase its own shares from existing shareholders. This is done either through the stock exchanges or by making a direct offer to the existing shareholders. In simple words, the company uses its own money, i.e., usually from its reserves or surplus cash, to reduce the number of shares available in the market. This enables the company to give money back to shareholders while also increasing the value of the remaining shares, as fewer shares are now available for trading.
Share buybacks are regulated by the Companies Act, 2013 (Sections 68, 69, and 70) and the SEBI (Buyback of Securities) Regulations, 2018 in India. These laws specify how much of the company’s reserves can be used for buybacks, the maximum limit of shares that can be repurchased (up to 25% of paid-up capital and free reserves in a financial year), and the permissible ways or methods for such buybacks. A buyback often signals that the company is confident about its financial health and wants to reward shareholders while believing its stock is undervalued.
A company can opt for a share buyback due to multiple reasons that can range from utilising surplus cash to avoiding potential takeovers. Some of the possible reasons for share buyback are explained below.
When a company earns more profits than it immediately needs for business operations or future investments, it ends up with a large cash reserve. Keeping too much idle cash is not always productive, as it does not generate much return. In such cases, instead of simply holding on to this money, companies often prefer to return a portion of it to shareholders through a share buyback. This acts like a reward and makes investors feel that their investment is directly paying off.
After a buyback, the total number of shares in the market reduces. Since the company’s profits are now divided among fewer shares, the earnings per share (EPS) automatically increase. A higher EPS makes the company’s stock look stronger and more attractive to investors. Over time, this can also support a higher share price, directly benefiting long-term shareholders.
Companies aim to maintain an efficient balance between equity (shares) and debt (borrowings). If the equity base becomes too large, buybacks help reduce it, thereby optimising the company’s capital structure. This can reduce the cost of capital and make the company financially more efficient.
Share buybacks can also make a company’s financial performance look stronger. By reducing the number of outstanding shares, key ratios like Return on Equity (ROE) and Return on Capital Employed (ROCE) improve. Investors often look at these ratios before deciding where to invest, so stronger numbers can boost market confidence and valuation.
In certain cases, a buyback can also serve as a defensive strategy. If too many shares are freely available in the market, an outsider could potentially buy a large chunk and attempt to take control of the company. By reducing the number of free-floating shares through a buyback, companies make it more difficult for such hostile takeovers to succeed.
Companies that generate consistent cash flows often build up large reserves over time. If they do not find attractive opportunities to invest in new projects, acquisitions, or expansions, they risk holding on to idle funds. A buyback is an efficient way to use these reserves while still keeping investors happy.
A share buyback often sends a strong message to the market that the company’s management believes its stock is undervalued and has strong growth potential. This positive signal builds confidence among existing investors and can attract new ones. At the same time, buybacks are frequently done through the tender offer route in India. This involves companies repurchasing their shares directly from shareholders at a price higher than the market value. This allows long-term investors who participate in the buyback to earn an immediate profit, making it a rewarding experience for loyal shareholders.
A company opting for share buybacks can do so based on certain rules and restrictions set by SEBI and the Companies Act 2013, and must make full disclosures to SEBI and stock exchanges to maintain transparency for investors. A few key rules to be followed by such companies include,
Maximum Limit -
A company can buy back up to 25% of its paid-up capital and free reserves in a financial year.
For equity shares, this 25% limit applies only to the total equity capital.
Debt-Equity Ratio -
After the buyback, the company’s total debt should not be more than twice the equity (i.e., a maximum debt-to-equity ratio of 2:1).
Sources of Funds -
Buybacks can be funded only through the following options.
Free reserves (profits kept aside),
Securities premium account, or
Proceeds from earlier issue (but not from fresh issue of shares)
Modes of Buyback -
Companies can carry out buybacks in primarily the following ways,
Tender Offer (buying shares directly from existing shareholders at a fixed price).
Open Market Purchase (buying shares from the stock exchange).
Approval Requirement -
If the buyback is up to 10% of the company’s paid-up capital and free reserves, the Board of Directors can approve it.
If it exceeds 10% (but within the 25% limit), it needs approval from the shareholders via a special resolution.
Time Frame -
Once announced, a buyback must be completed within one year from the date of approval.
No Fresh Issue of Similar Shares -
A company that has done a buyback cannot issue the same kind of shares or securities for six months, except by way of bonus shares or conversion of existing obligations (like warrants or stock options).
Frequency Restriction -
A company cannot make another buyback within one year of completing a previous one.
Mandatory Extinguishment -
All shares bought back must be extinguished (cancelled) within 7 days of the buyback’s completion. This ensures the shares are permanently removed from circulation.
The primary methods used by companies for share buybacks are,
In this method, the company makes a direct offer to its existing shareholders to buy back shares at a fixed price. This price is usually higher than the current market price, so that investors are encouraged to participate. Shareholders who wish to take part can ‘tender’ (offer) their shares to the company within a specified time frame. Once the buyback is completed, the company cancels these shares. Many large companies like Infosys, TCS, and Wipro often use this method because it is straightforward and benefits loyal long-term shareholders by giving them a chance to sell at a premium.
Under this method, the company buys back its shares directly from the stock exchange, just like any other investor would. The buyback happens at the prevailing market price, and the company usually announces a maximum price it is willing to pay. This method gives the company flexibility, since it can spread the buyback over time and choose the right moments to purchase shares. However, unlike the tender method, not all shareholders may benefit equally, because only those who sell in the market during the buyback period will be able to participate.
Many companies also use buybacks to purchase shares held by employees under ESOPs (Employee Stock Option Plans). ESOPs are shares given to employees as part of their compensation or as incentives. Sometimes, employees may want to liquidate these shares for a favourable price, and the company facilitates this by buying them back. ESOP buybacks not only reward employees by giving them a chance to convert their stock options into cash but also improve employee morale and retention. This is also a way for the company to show that it values the contribution of its workforce.
The company’s decision to buy back its shares can have immediate or short-term impact as well as a lasting one on the share price and the company’s fundamentals. The impact of share buyback on share price is explained below.
When a company announces a buyback, the stock price usually goes up in the short term. This happens because investors see the buyback as a sign of financial strength and management confidence. The company’s willingness to spend its own money to repurchase shares often creates excitement in the market, leading to a quick price rally. For example, when Infosys or TCS announces a buyback, their shares often jump right after the news.
In the long run, a buyback can increase the company’s Earnings Per Share (EPS) because profits are divided among fewer shares. A higher EPS often makes the stock look more attractive to new investors and can push the share price higher over time. Thus, buybacks not only give short-term gains but also support sustainable growth in shareholder value.
Perhaps the biggest effect of a buyback is psychological. It signals to the market that the company has no better use of its cash than to invest in itself. This builds trust, attracts new investors, and creates a ripple effect of optimism that can keep the share price strong even beyond the buyback period.
Buybacks also act as a safety net for the company’s stock price during market ups and downs. Since the company itself becomes a buyer of its own shares, it creates additional demand. This helps stabilise the share price and prevents it from falling too sharply during uncertain times. For long-term investors, this adds a layer of comfort.
While buybacks usually cause a price rise, the long-term effect depends on the company’s performance. If the business continues to grow and profits improve, the share price remains strong. However, if the buyback is only a short-term move to boost sentiment without real growth, the price may fall back once the excitement fades.
Share buybacks are a form of distribution of profits, as the funds used for buybacks come from the distributable profits. However, there are a few key differences between the two forms of sharing profits with the shareholder. These differences are explored below.
The tax treatment of share buyback has recently undergone a drastic change, thereby changing the liability of paying tax in India. The tax treatment of share buyback is explained below.
Earlier, the burden of tax was not on shareholders but on the company itself. Under Section 115QA of the Income Tax Act, the company had to pay a buyback tax of about 23.296% (including surcharge and cess). This tax was charged on the difference between the buyback price and the original issue price of the shares. For investors, this meant that the money they received from selling their shares in a buyback was completely tax-free in their hands. Shareholders did not have to declare or pay any extra tax on such income.
From October 1, 2024, the rules have changed significantly. The tax liability has shifted from the company to the shareholder. Now, any amount you receive from a company when you tender shares in a buyback is treated as dividend income under Section 2(22)(f) of the Income Tax Act.
The entire amount received will be taxed as ‘Income from Other Sources’ for resident shareholders at their applicable income tax slab rate. Thus, if they are in the 30% tax bracket, the whole buyback amount will be taxed at 30%.
Companies are also required to deduct TDS (Tax Deducted at Source) at 10% before paying you, if you are a resident shareholder.
For non-resident shareholders, taxation will depend on the relevant tax rates and Double Taxation Avoidance Agreements (DTAAs) with their home countries.
Investors should look at share buybacks with both opportunity and caution. A buyback can still be a good chance to earn money, especially if the company is offering a higher price than the current market value. However, after the tax changes from October 2024, the money received in a buyback is fully taxed as income at the investor’s slab rate, which reduces the net benefit, especially for those in higher tax brackets. Because of this, investors should first check how the tax impact fits into their personal situation. Those who need quick cash may still choose to tender their shares, while long-term investors may benefit more by holding on to their shares and enjoying possible price appreciation after the buyback. It is also important for investors to remember that the cost of their shares can be recorded as a capital loss and used to reduce taxes on future capital gains. Overall, investors should carefully compare the after-tax benefit of selling in a buyback with the option of keeping their shares for long-term growth, and then make a decision that matches their financial goals.
Share buybacks are an important tool in the corporate world, helping companies return extra cash to shareholders, improve financial ratios, and send positive signals to the market. Buybacks can create short-term price gains and long-term value for investors, thereby making them an effective form of reward apart from dividends. With the recent tax changes, share buybacks have become expensive for taxpayers belonging to higher tax brackets. Thus, investors must approach them with careful planning and clear financial goals.
This topic talks about an important corporate action and its impact on the share prices and the overall company. Let us know your thoughts on this topic or if you need further information on the same.
Till then, Happy Reading!
Read More: Impact of Mergers and Acquisitions on Corporate Valuation and Stock Prices
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
Thestock market never stands still, and prices swing constantly with every new h...
Share prices of a company are affected by numerous external and internal factors...
Analysing the financial statements is the first step in the fundamental analysis...
