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.
Net Assets per share
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.
For example,
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.
Working Capital
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.
Potential Advantages
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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.
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Higher Dividend - The reduction of share capital may increase the likelihood of a higher dividend rate being declared in the future.
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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.
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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.
Potential Disadvantages
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Reduce the financial reserves that may be available for distribution to the shareholders in the foreseeable future.
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Result opportunity costs as better investment opportunities may be foregone in the future due to insufficient financial resources upon implementing the Share Buy-Back.
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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
http://xaivierchia.blogspot.com/2014/04/share-buy-back-authority-review.html
Pak Lah
There are 2 causes that can possibly prompt the share buy back but not highlighted in this article. These two are commonly practised in this country. First, share buy back is intensified when the share prices drop drastically and result in margin calls for the major share holders, e.g. Parksonn? Second, share buy back takes place when major shareholders would like to make an exit. This exit is not necessarily announced in the Bursa as the major shareholders may have other proxy accounts, e.g. Bjtoton? To buy back the shares, the directors will cook up reasons to convince the shareholders to get the required approval. We must therefore exercise extra cautions as share buy back can arguably be done to benefit the major shareholders but at the expense of the retailed investors.
2014-04-19 08:40