Treasury shares are akin to a company’s financial reserve, similar to an individual’s emergency fund. These shares are not actively traded on the market, nor are they listed as assets in the company’s balance sheet. Instead, they remain in the company’s treasury for future use.
Treasury shares often contribute indirectly to increasing the value of the company’s outstanding shares. By reducing the overall number of shares available for trading, the value of remaining shares can appreciate. However, these shares themselves do not add direct value and are recorded in contra accounts within the balance sheet. They function as a strategic reserve, offering flexibility for a range of corporate purposes.
Let us understand the meaning of treasury stocks in detail and learn why a company re-purchases its own shares. Furthermore, we will also explore certain key legal provisions governing the process of share buyback in India.
What are treasury shares?
Also referred to as “reacquired shares,” treasury shares are stocks initially issued by a company but later repurchased. Once reacquired, these shares are held in the company’s treasury rather than being retired. They are not publicly traded but serve strategic purposes.
Companies may acquire treasury shares through methods such as open market purchases or employee stock option plans (ESOPs). These shares are instrumental in:
- Increasing stock prices
- Defending against hostile takeovers
- Compensating employees through ESOPs
- Providing liquidity for shareholders
What is the treasury stock method?
The treasury stock method calculates the impact of dilutive securities like stock options, warrants, and convertible instruments on earnings per share (EPS). It assumes the proceeds from exercising these securities are used to repurchase shares in the open market, which are then classified as treasury shares.
The number of additional shares is determined by dividing the proceeds from these securities by the average market price of the stock during the reporting period. This number is added to the outstanding shares for EPS calculations.
Treasury stock formula
Additional shares outstanding = n x (1 – K / P)
Where:
- n = Number of shares from exercised options and warrants
- K = Average exercise price (strike price)
- P = Average share price for the reporting period
This method is widely used in financial reporting to assess the potential effects of dilutive securities on a company’s financial metrics.
Features of treasury stocks in India
- No voting rights: Treasury shares do not confer voting rights.
- No dividend payments: These shares are ineligible for dividend payments.
- Excluded from EPS calculation: Treasury shares are not factored into EPS, which may increase the EPS for outstanding shares.
- Reduction in equity: Treasury shares decrease shareholders’ equity, impacting key ratios like debt-to-equity.
- Company discretion: Companies decide whether to hold, reissue, or resell these shares.
- Strategic flexibility: Treasury shares offer flexibility for acquisitions, employee compensation plans, or market stabilisation.
Factors to consider before investing in treasury stocks in India
- Company’s financial stability: Verify the company’s financial health.
- Purpose of buyback: Understand the rationale behind the buyback.
- Regulatory compliance: Ensure adherence to SEBI guidelines.
- Valuation: Compare the buyback price with the market value.
- EPS impact: Evaluate the influence on EPS.
- Market conditions: Analyse the prevailing market environment.
- Dividend vs capital gains: Decide your preference between income types.
- Long-term strategy: Align with your investment goals.
- Tax implications: Consider tax consequences.
- Exit strategy: Develop a clear exit plan.
How to invest in treasury stocks in India?
Investing in treasury stocks (or government securities) can be achieved through various channels:
- Primary dealers and banks: Direct investments in G-Secs.
- Stock exchanges: Trading on platforms like NSE and BSE.
- Retail direct gilt accounts: Offered by the RBI and select banks.
- Mutual funds and brokers: Indirect avenues for investment.
- Online platforms: Accessible trading through apps and websites.
- Savings schemes: Options like National Savings Certificates (NSCs).
Factors such as tenor, interest rates, and tax implications should be carefully assessed to align with individual financial goals and risk tolerance.
Reasons for acquiring treasury stocks
- Boosting stock prices: Reduces supply, increasing demand and stock price.
- Preventing hostile takeovers: Limits the availability of shares for potential acquirers.
- Compensating employees: Enables stock-based employee benefits through ESOPs.
- Providing liquidity: Reduces the number of shares available for trading while offering liquidity for shareholders.
Conclusion
Treasury stocks are shares repurchased by a company from the open market. As a strategic corporate move, this often increases investor confidence and shareholder value. Companies buy back shares to increase their share price, boost earnings per share (EPS), and optimise capital structure.
Furthermore, these treasury shares can be re-issued for fundraising and employee compensation purposes. The share buyback process is governed by the Companies Act 2013, which protects shareholder interests and maintains financial discipline.
