Treasury stocks, also known as reacquired stocks, is the portion of a previously issued stock that a company has purchased (bought back) from its shareholder. These stocks are held by the company and are used for its disposition.
These stocks can remain in the company’s possession or may also be used for future issuing to prospective shareholders. Also, a company may decide to retire these shares permanently from the market; thereby, they will not be available for any use.
Where Is A Treasury Stock Reported?
The treasury stock finds a mention in the balance sheet under the shareholder’s equity section. It is one of the various types of equity accounts and is generally mentioned as a contra-equity account.
Understanding The Framework Of Treasury Stocks
Every company is allowed to issue a certain number of shares. These shares are called “outstanding shares.”
Of these shares, some are publicly traded, whereas some are restricted shares (it means that these shares can’t be sold unless certain conditions are fulfilled).
Treasury stocks are the stocks that are initially a part of outstanding shares and were held by an entity (individual or organization). However, these shares are repurchased by the company from its shareholders.
What Is The Intention Behind Share Repurchase?
Following are some of the reasons why a company may decide to repurchase its shares from its shareholders –
As highlighted above, treasury stocks are repurchased from the shareholders by the company. A company may use the treasury stock as the reserved stock that is kept aside for raising future funds and/or pay for future investments
.A company may also use these stocks for completing an investment, including acquisition or merger of a business. Moreover, these shares can be reissued to new or existing shareholders depending on the business decision.
For gaining a controlling interest
The purchase of shares by a company lowers the number of outstanding shares.
This action, therefore, results in a reduction in the denominator value, thereby resulting in an increased percent holding for the existing investors.
Stock reacquisition prevents hostile takeovers when the management is not willing to execute the acquisition deal.
In times when the market is volatile or is not performing well, a company’s stock may also not perform well and remain undervalued to its intrinsic value.
In these circumstances, buying back the share from the market or shareholder’s direct results in increasing the price of the stock. This generally benefits the remaining shareholders.
Retiring of shares
When treasury stocks are retired, they cannot be sold and thus are taken out from the market. This move results in a reduced number of shares, thereby impacting the holding of existing shareholders, dividends, and profit distribution.
Improving financial ratios
With the move of buying back shares (treasury stocks), the financial ratios get altered. Also, if these shares are retired permanently, there is an increase in the return ratios such as return on assets (ROA) and return on equity (ROE).
Limitations Of Treasury Stocks
Treasury stocks come with certain restrictions. Following are the limitations of such stocks –
- Comes with no voting rights
- Not entitled for any dividend
- Not a part of outstanding shares computation
- No preemptive rights as a shareholder
- Not entitled for receiving the net assets of the company upon liquidation
- Regulatory angle around treasury stocks
Not all countries have laws governing the treasury stocks, but some countries have put in place some regulation around the stock category. In some countries, the number of treasury stocks cannot exceed the maximum proportion of capitalization specified by law.
How Do Companies Buyback Stocks?
A stock buyback or repurchase (as it is called usually) is a methodology by which the management of a company can reduce the number of outstanding shares circulating in the market. The company’s remainder shareholders are likely to benefit owing to the rise in relative ownership. Following are the methods by which a company may carry out the repurchase:
A company offers to repurchase the shares from existing shareholders at a specified price that the company is willing to pay. This specified price is generally at a premium to the market price. The company also discloses the duration for which the buyback offer is valid. Once the tender offer is released, the shareholders who are willing to sell their holding in the company may tender their share within the due date for repurchase.
Open market operation
Also known as direct purchase, the open market operation is nothing but buying back the shares directly from the exchange. Whenever a company announces buyback, the action is generally considered as positive, thereby leading to an increase in the share price. The company then proceeds to purchase the shares like any other investor in the market.
In this route, the company announces its willingness to buy back its shares. Also, the company announces the price range in which it is looking to repurchase the shares along with the date range in which the offer is valid.
An existing shareholder who is willing to participate may tender his/her interest with a price from the defined price band. Once the company receives the interest of all shareholders, it purchases the desired number of shares for the lowest cost possible.
This is done by reviewing the offer given by the shareholder.
Disclaimer: The views expressed in this post are that of the author and not those of Groww
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