Friday, July 31, 2009

What is Share Buy Back and The Benefits

If you are already investing in the stock market or you are reading financial news from newspaper, you might have came across news about Share Buy Back. So, what actually Share Buy Back means? What are the benefits of Share Buy Back?

In this post, I am going to discuss about Share Buy Back and the effect of Share Buy Back towards the stock price of a company. Basically, from the words itself, "Share Buy Back", you can easily guess that it means buying back share. But, who will be buying back the shares? Let's make it simple. Share Buy Back means a company declare that it is going to buy back their company's outstanding shares in the market. (In case you do not understand what is outstanding shares, it means shares in the market.)

Company will buy back their outstanding shares in the market with large sum of money and the share buy back is normally large quantity of shares. In other terms, Share Buy Back also means repurchase of outstanding shares.

Company will buys back their share due to some reasons:
1. Buying back their outstanding shares can increase the price of share [Why share price will increase?]
2. Buying back their outstanding shares in order to eliminate threat of being controlled or eliminate shareholders who might be trying to take control of the company.
3. Reducing the number of shares in the market.

Share Buy Back can be beneficial to shareholders. Share Buy Back reduces the number of outstanding shares in the market and thus this reduce the supply of certain stocks in the market.

For example:
Comapny A has 100,000 outstanding shares. Now, the company is declaring Share Buy Back of 20,000 outstanding shares.

The Number of Outstanding Shares after Share Buy Back
= 100,000 - 20,000 = 80,000 outstanding shares.

Thus, we can see that the outstanding shares have been reduced to 80,000 shares. If we have less share of Company A in the market, this means that the share of Company A we are holding now worth more than before, right?

How Does it Affects the Price of the Stock? [Why Share Price will Increase?]
Ok, here we need to do some simple calculation.

Let say that the share price of Company A is RM1.00 with 100,000 outstanding shares. This means that if all the 100,000 shares are being sold to shareholders, then Company A will get RM100,000 to invest in their business.

Now, that Company A, Buy Back 20,000 shares from the market and only 80,000 shares are left in the market. What do you think the price of the shares will be?

Originally: RM 1.00 per share 100,000 outstanding shares
After Share Buy Back: 80,000 outstanding shares

So, now, in order to get RM 100,000 from 80,000 outstanding shares, the price of share should be increased.Right?

The price per share after Share Buy Back = RM 100,000/80,000 = RM 1.25 per share.

The new price of the share would become = RM 1.25 per share.

So, if you have bought share of Company A at RM 1.00 per share, you would have profited with gain of RM 0.25 per share.

From the calculation, we can see an increase of share price of Company A. Bear in mind that, this calculation is basically theoretical idea. The price of the share will have high tendency of moving up but other factors will also affect the price change.

Other Benefit of Share Buy Back:
Share Buy Back also affects Earning Per Share. This part will be further discussed in another post because I do not want to confuse you with too many calculations and theories. Read this post again if you do not understand at first read.Try to do some calculation using your calculator. You would find it interesting to know about Share Buy Back.

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