Many companies announce share buybacks—but have you ever wondered why?
Before we get into that, let’s clear one thing up: not all buybacks are a good sign. In fact, some companies use them as a tricky strategy.
But before diving into these tricks, let’s understand a basic concept.
What Are Corporate Actions?
A company’s decisions can impact shareholders, either positively or negatively. These decisions are known as corporate actions, and they include dividends, stock splits, bonus issues, rights issues, and, of course, buybacks—the topic of today’s discussion.
What Is a Share Buyback?
A buyback is when a company repurchases its own shares from shareholders. Companies usually conduct buybacks when they have strong profits, excess cash, or a growing business.
They could also distribute this extra cash as dividends, but buybacks serve another purpose.
The EPS Trick: How Companies Play the Game
Let’s say you’re a shareholder in a company.
- The company’s total sales = ₹10,000
- After expenses, net profit = ₹2,000
- Total shareholders = 100
Now, if the profit is divided among all shareholders:
₹2,000 ÷ 100 = ₹20 per shareholder
In stock market terms, this is called Earnings Per Share (EPS), calculated as:
EPS = Net Profit ÷ Total Outstanding Shares
So here, the EPS is ₹20.
Now, let’s say the company buys back 20 shares. The number of outstanding shares reduces to 80, but the profit remains ₹2,000.
Now, the new EPS is:
₹2,000 ÷ 80 = ₹25
EPS has increased from ₹20 to ₹25. But did the company’s business actually improve? No! The only reason EPS increased is that the number of shares decreased.
This is a classic financial trick used to make the company’s earnings look better without any real business growth.
The Dark Side of Buybacks
Some companies take this to another level by taking loans to conduct buybacks!
So, how do you spot a problematic buyback?
- If a company has no sales or profit growth but announces a buyback—that’s a red flag.
- If a company takes debt to fund a buyback—that’s another warning sign.
Not all buybacks are bad, but if they are used just to manipulate financial numbers rather than support real growth, it’s a risky sign.
The Bottom Line
Always invest in companies with strong fundamentals and real growth, not just flashy financial tricks.
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