What is Treasury Stock?

Key Highlights

• The Treasury stock is the previously outstanding shares that have been repurchased and are held by the issuing company.
• Treasury stock is referred to as a contra-equity account since it lowers the overall shareholders' equity on an entity's balance sheet.
• The cost method and the par value method are the two accounting techniques for Treasury shares.

Understanding Treasury Stock

Treasury stock, also known as reacquired stock, is the outstanding shares of stock that a business has bought back from its shareholders after they were originally issued. The company will then hold the newly acquired shares and dispose of them. If the company wishes to sell the shares in the future, they may remain in the company's possession, or the company may retire the shares and keep them out of the market forever. As a contra-equity account, treasury stocks are one of the different types of equity accounts presented in the balance sheet section as part of shareholders' equity.

A certain number of shares are authorized to be issued by each company. That is called the outstanding shares, or the total number of common shares available to a company. Some of these outstanding shares are restricted, meaning that they cannot be traded unless certain conditions are met, while the majority of shares are traded on the open market, known as the float. The stocks in the treasury are those that had originally been part of the outstanding shares but were subsequently bought back by the company.

What is the Intention behind Share Repurchase?

The reasons for which a company may decide to buy back shares from its shareholders are given below.

1. For Re-selling

The company buys back Treasury shares from its shareholders, as described above. In order to raise future funding and for investment purposes, a company may use the reserved stock, which is held in reserve, as treasury shares.

A corporation may also use these stocks to complete an investment, such as the purchase or merger of another company. Furthermore, depending on the business decision, these shares may be reissued to current or prospective owners.

2. Undervaluation

The company's shares may not perform well and remain undervalued at their intrinsic value in times of volatility or poor performance on the market. Under these conditions, the buying back of shares from markets or shareholders directly increases stock prices. In general, this would benefit the other shareholders.

3. To Gain Control over One's interests

The number of outstanding shares is reduced when the company buys its shares. Therefore, this action causes the denominator value to decrease, increasing the existing investors' percentage holding. Repurchasing stocks stops attacks in cases where management is unwilling to carry out the acquisition agreement.

4. Retention of Shares

When Treasury stocks are retired, they're not allowed to be sold and are therefore withdrawn from the market. This change will lead to a reduction in the number of shares, thus affecting existing shareholders' holdings, dividends, and profits.

5. Improving financial ratios

With the move to buy back shares (treasury stocks), the financial ratios get altered. Return ratios, such as return on assets (ROA) and return on equity (ROE), may increase if these shares are retired permanently.

How do Companies Buyback Stocks?

The method by which a company's management can decrease the number of shares that are retained on the market is stock repurchase, or outright purchase, as it is commonly referred to. Given the increased relative shareholding, other shareholders in the company are likely to benefit. The methods by which the company is allowed to repurchase its shares are as follows:

1. Open Market Operation

Open market operations, also known as direct purchases, are nothing more than the purchase of shares directly from the exchange. When a company announces that it will buy back its shares, the action is widely regarded as favourable and leads to an increase in the share price. As an investor in the market, the company then proceeds to buy the shares.

2. Tender Offer

A firm offers to buy back its shares from existing shareholders at a price that it is willing to pay. Generally speaking, this fixed price is higher than the market price. The company shall also disclose the period of validity of the repurchase offer. If a shareholder wants to sell their shares in the company, they can tender their shares for repurchase within the deadline after the tender offer is announced.

3. Dutch Auction

The company confirms its willingness to buy back its shares in this way. The company further announces the price range in respect of which it would like to buy back its shares, together with the date on which that offer is valid.

Limitations of Treasury Stocks

There are some restrictions on the stocks of the Treasury. The restrictions on these stocks are set out below.

• No voting rights.
• You're not entitled to a dividend.
• Not included in the calculation of the outstanding shares. As a shareholder, you should not make use of preemptive rights.
• If the company liquidates, it will not be entitled to receive any net assets.
• The total amount of treasury stock that a company can hold is limited in many countries by legislation, so it cannot go above the maximum percentage of capitalization that is allowed.

Conclusion

As treasury shares are not allowed to be traded by the public, they do not provide dividends or have voting rights. Despite their low intrinsic value, Treasury shares have more uses in the market and corporate structure than originally appeared. They also serve as a line of defence against takeovers, in addition to serving as a future fund for the company. To invest in any kind of stock, check out Kotak Securities online trading platform.