When a company buys back shares, it results in a reduction of the number of shares outstanding and the capital base. To that extent, it improves the EPS and the ROE of the company. When the EPS goes up, assuming the P/E remains constant the price of the stock should also go up. However, in practice it does not normally happen. When a company buys back shares it is seen as a business with very limited future investment and growth opportunities. Hence, such companies tend to quote at lower P/E ratios since P/Es are normally driven by growth. So, while the EPS goes up the lower P/E tends to neutralize the impact on valuation.4.Company can signal that the stock is undervaluedThis is perhaps the main signals that companies like to send out by buying back shares of the company. The fact that the company has confidence to use its reserves tobuy back its own shares give a hint that the company management perceives it as undervalued. This is more relevant in the case of stocks that have corrected sharply despite no apparent fundamental flaws. Under these circumstances, it could be a good idea for the company to buy back the shares and signal the bottoming of prices. Whilethe stock may not appreciate sharply, it helps the stock find a bottom in most cases. 5.Returns cash to the shareholders of the companyIn India, shareholder activism by large shareholders and institutions is still not too prominent, but it is gradually building up. For example, in the US companies like Apple were forced by influential shareholders to distribute more cash to shareholders
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- Winter '17
- Prof Natwar Lal
- Passing, HCL Technologies