Why is Bajaj buying back its shares? What are stock buybacks?

Bajaj Auto has approved the buyback of shares worth up to Rs 2,500 crore. This means that it can buy back 54,34,782 shares (Rs 4,600 per share), which is 9.61% of its share capital. 

Bajaj Auto's shares, which are currently trading at Rs 3,887 (June 28, 12.30 pm), will be purchased back from the existing shareholders through the open market ie. the National Stock Exchange (NSE), and the Bombay Stock Exchange (BSE).

BUT WHAT IS A SHARE BUYBACK?    

Remember how companies give you their shares when you apply for an IPO and pay them money? Well, buyback is the opposite business, where you get paid to sell your shares back to the company. 

Pappu is an 18-year-old from Delhi who keeps a tab on the hot stocks in the market. When he got to know that Nestle gives a great return on its stocks (apart from selling his girlfriend's favorite 'Cadbury Silk'), he thought of investing some money in Nestle for the long term. Why does Nestle give great returns? Well, Pappu's girlfriend demands a Cadbury Silk every week for all 52 weeks.

Since many of his friends have a similar fate, he knows that Cadbury will always be in demand. And his Youtube teacher asked him to always buy stocks of the companies which sell goods that he frequently uses and needs. So he decides to buy Nestle shares, no matter what the price!

When Pappu and his friends go shopping for Nestle shares on the NSE website, he finds that these shares cost just 100 bucks! (this is a story guys, just believe this for a moment) But he had read somewhere that the actual value of a Nestle share is expected to go up to Rs 200 in the future.

'Lucky us, this is so cheap!' he tells his friends. Pappu and his 4 friends end up buying 10 shares each for just Rs 1000.  

Two months later when Nestle's share price on the stock market reach Rs 130, Pappu and friends get a DM from Nestle:

'We want to buy the Nestle shares that you and your friends hold right now and we'll pay you Rs 160 per share.'

Now, what will Pappu and gang do?

• Pappu and friends can sell all of their 10 shares to Nestle
• Can sell none to Nestle. It's their choice.  
• They can even sell a part of their 10 shares and keep the rest with themselves. 

What they need to evaluate is whether they want to receive cash of Rs 160/share right now by selling their shares to Nestle or receive this money eventually when the share price rises a few months (or years later) and selling shares at that time. 

BUT WHY WILL A COMPANY BUY BACK ITS SHARES?

There are a lot of real-life scenarios which can cause Nestle to opt for a buyback: 

1. If Nestle has loads of cash in its bank and nothing to spend it on: Nestle is usually researching and creating new products like Lava Cakes, New Cadbury Silk chocolates and so much more. But if it does not have anything to spend on, Nestle can choose to give the money back to shareholders instead of holding it on or saving it for a rainy day. 

2. If Nestle wants to raise its share prices: When Nestle asks for Pappu and gang's shares, Pappu is sure to wonder, 'Why is Nestle buying MY shares? No company would buy shares today if they knew it was going to make losses in the future. So maybe the share prices are going to rise''. Say, Pappu's friends are stupid or cash-hungry and sell their shares to Nestle. Once Nestle buys back its shares, the total available shares in the market will be reduced, thus only a few will have their hands on precious Nestle shares. This reduction in the supply of Nestle shares will lead a lot of people to rush to buy these shares and increase Nestle's share price immediately.

 3. If Nestle wants to polish its financials: Pappu always looks for a company's earnings per share (EPS) on investment websites and the company's financials. EPS indicates how much investors can make from each share and is calculated by dividing earnings by the number of existing shares in the market. So, if Nestle's profits are Rs 10,000 and it had a total of 1,000 shares before the buyback, its EPS would have been 10 (Rs 10,000/1000 shares) before the buyback. But if Nestle buys back 500 shares, the EPS now changes to 20 (Rs 10,000/ 500 balance shares that are held by Pappu). This boosts the company's valuations and its PE Ration (another evaluation tool like EPS) If Pappu does not sell his shares during the buyback, he will tell the world how his Cadbury stock gives him an EPS of 20!!! While his friends who sold Nestle's shares will probably rejoice over receiving Rs 160 per share today! 

Would you sell your shares if a company bought back the shares that you held?