Buyback is the process of reducing a company's shares available in the stock market. Consider buyback as a company investing in itself, or using its cash to buy its own shares.
How buyback is accomplished?
In India buyback is done in two ways, both the methods have been specified by the Securities and Exchange Board of India (SEBI), the capital market regulator of the country.
A company can either buyback from existing shareholders on a proportionate basis, known as tender offer. The other method is that it can buyback through the stock exchange, usually referred to as open market purchase, this process is also called reverse book-building.
Under the tender offer, i.e. the first method, a company's shareholder have the option to give a portion or all of their shares within a certain time frame. The shareholder's are also expected to state the price they are willing to accept from the company.
Then the company will stipulate both the number of shares the company is looking to repurchase and the price range they are willing to pay. The company will try and find the right mix to buy the shares at the lowest cost.
The other method is to buyback shares on the open market, which is done over a period of time. Usually this period covers a time frame of one year.
The company announces a ceiling price, it is the maximum price per share that the company is ready to pay. The company will also announce the maximum amount which it will spend on the buyback.
What is the purpose of buyback?
Once buyback happens the relative ownership stake of each investor increases because there are fewer shares of the company. This results in automatic increase in the earnings per shares.
In the near term, share buybacks can boost the share price of a particular company. However, over the long period, it still boils down to the company's fundamentals.
It is a better deal when the shares are comparatively undervalued as against their fundamentals -- large reserves, cash flow and how it stands in its industry -- because then buyback would be perceived as a good move by the management. It would also prompt buying interest in the stock.