• HDFC securities
• 27 Mar 2023
• Knowledge Centre

 

Treasury stocks are outstanding shares that are bought by the issuing company from its shareholders. In simple terms, these are previously issued shares that are reacquired or bought back by the company. These stocks are then held by the issuing company for its disposition. The company may choose to keep them in their possession, sell them in the future, or may even choose to retire these stocks, taking them completely off the market.

Treasury shares are mentioned on a company’s balance sheet under the shareholder’s equity section as Contra-Equity Account.

A company issues a certain number of shares which are known as outstanding shares. Among these outstanding stocks, most are publicly traded and known as float, while some are restricted stocks that cannot be traded until certain special circumstances arise.

Treasury stocks are part of a company’s outstanding stocks. These stocks are generally repurchased from the open market. This is known as buyback stocks.

Intention behind buying back stocks

• Re-selling

Many companies utilise Treasury stocks as reserved stocks kept aside for raising funds in the future or paying for future investments. It may also be kept reserved for facilitating business acquisitions or mergers. The stocks can also be reissued to new and existing stockholders.

• Gaining a controlling interest

Gaining a controlling interest is another reason a company may choose to buy back its stocks. By buying back shares, the total number of outstanding shares decreases and the percentage holding of the existing investors increases.

• Combat undervaluation

During volatile times, there is a possibility that the company’s stock prices may also take a hit and trade at lower values. The company can buy back its shares which results in an improvement in stock price, benefiting existing shareholders.

• Improving financial ratios

As a company buy back its stocks its financial ratio gets altered. Furthermore, if the company chooses to retire its stocks altogether it causes an increase in the company’s Return on Equity (ROE) and Return on Assets (ROA). This is seen positively both by the company and stockholders.

Process of buying back stocks

A stock buyback or repurchase can be made by a company in the following ways:

• Open market operation

It is the most popular way to buy back stocks. It is also known as the direct purchase wherein the company buys back stocks directly from the market.

• Tender offer

The company releases a tender stating the specific price at which it is willing to buy back shares from its shareholders. The price is typically higher than the ongoing market price. The validity of the tender offer is also mentioned. If an investor finds the price to be fair, he can choose to sell his shares to the company before the due date expires.

• Dutch auction

In the Dutch auction method, the company announces the price range and the number of shares it is willing to repurchase. Investors can participate by making a tender, highlighting the price they find suitable for the repurchase from the defined price range. Once all tenders are in, the company reviews them and purchases the desired number of stocks at the lowest possible price.

Limitations of Treasury stocks

Following are a few limitations of Treasury stocks:

• Treasury stocks have no voting rights.
• There is no entitlement to dividend income.
• Possess no shareholder rights.