subject: Why Companies Buy-back Shares At Higher Price Than Market Price? [print this page] Buying back is a strategy in which companies buy back its shares from share holder at higher prices than prevailing price in market. Companies buy back its shares because it does reduce its market capitalisation by reducing its numbers of shares outstanding. The question is that, why companies buy their own share on higher prices? The reasons are simple, firstly, what if company holds great amount of reserves but it has no upcoming projects to invest in than what is more fruitful then invest that money by their own in different projects and offer attractive prices to the share holders to buy their shares. This will also bring dilution by reducing outstanding shares in the market.
Second reason to buy back shares is simply company wants to revalue its stocks, some times company thinks its stocks is undervalued in the market and company buy back its stocks and re issue them by projecting better value.
Third reason is, some companies want to change their capital structure and they use this buy back option as a tool to change their debt-equity ratio. Companies can increase their reliance on debt financing over equity financing through buy back their shares from open market on higher prices. In this way they can make their after tax cost of debt reduces as compare to shareholders returns.
The fourth reason is that, many companies more often want to improve their financial ratios, such as:
Return on Equity, Return on asset and Earning per share
Company buys its stocks to reduce cash assets, which results in higher return on investments and in similar way due to reduction in outstanding shares the return on equity increases. By reducing outstanding shares, companies divide its earning per share amongst lesser number of shares for calculating earning per share amount. Important thing here is although earnings are still same but earning per share value of post buy-back will increase.
The company uses buy back option according to above reasons but this buy back option is always good for investors point of view. Investors always ended up with profits because of higher prices as compare to market prices.
by: Ayaz Haider
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