Treasury stocks constitute a unique aspect of a company’s financial structure, representing shares that the company has repurchased from the open market. These shares, which were originally issued and publicly traded, are now held in the company’s treasury. This strategic move allows companies to buy back their own stock, leading to various financial implications and influencing their equity structure. Let us find out more.
Table of Contents
Meaning of Treasury Stocks
The term treasury stocks is used to describe shares of a business’s stock that have been repurchased by the firm through a variety of strategies, including open market purchases, stock buybacks, or employee stock option exercises.
- They are not regarded as outstanding shares since they are kept in the company’s treasury, which means that shareholders do not own them and do not have voting rights.
- For a number of reasons, including increasing the value of the remaining shares by lowering the number of outstanding shares, boosting financial ratios like earnings per share, or offering liquidity for employees exercising stock options, companies may repurchase their own stock.
- The corporation can also use the treasury stock for a variety of things, such as awarding bonuses to staff, making acquisitions, or making strategic investments.
- Treasury shares do not appear on the balance sheet of the corporation as cash or cash equivalents. Instead, a stock account called treasury stock is used to track the cost of treasury stock.
Source of Treasury Stocks
Treasury stock can originate from a number of different places on the Indian stock market, including:
- Share Buybacks: Indian businesses have the option to repurchase their own shares on the open market. These shares are then kept in the business’s treasury.
- Employee Stock Options: Indian businesses may grant stock options to staff members, enabling them to buy shares at a reduced cost. The shares are repurchased by the business and kept in the treasury when employees exercise these options.
- Dematerialisation: Shares may also result from the process of dematerialisation, in which physical shares are transformed into electronic form and then maintained in a company account where they are referred to as treasury stocks.
- Acquisitions and Mergers: When one firm buys another, the shares of the acquired company are turned into the acquiring company’s treasury stock.
- Government Disinvestment: The government can also sell its position in a PSU through an IPO or a follow-on public offering (FPO). The government then holds the remaining shares, which are referred to as Treasury Stocks. Try Share India’s dividend yield calculator and quickly calculate the dividend yield of any stock.
Indian corporations are obligated to publish information about their treasury stock in their annual reports as well as notify the stock exchange of any share buybacks or other acquisitions.
Purpose of Treasury Shares
The aim of owning treasury shares can change based on the business strategy and financial objectives. Companies frequently maintain treasury shares for the following reasons:
- Buybacks of Company Shares: By lowering the total number of outstanding shares, companies can improve the value of their remaining shares. Additionally, this can enhance financial ratios like earnings per share.
- Employee Stock Options: To provide liquidity for staff exercising these options, companies may repurchase shares using employee stock options.
- Managing Capital: Treasury shares can be held by businesses to give them the freedom to manage their capital structure. They might use the shares, for instance, to make upcoming acquisitions or to give employees bonus shares.
- Defensive Ownership: Authority treasury shares may be held by companies to preserve ownership of the business, particularly when a hostile takeover is a possibility.
- Support Stock Price: In the event of a decline in market conditions, companies may maintain treasury shares to support the stock price.
- Investments for the Future: Businesses may maintain treasury shares to make investments for the future or seize growth opportunities.
- Distribution to Shareholders: Businesses may keep treasury shares on hand in order to split or pay out dividends to shareholders at a later time. Investors should consider a business’s treasury share position as part of their overall study of the firm because every company holds treasury shares for different reasons and according to different plans.
Advantages of Treasury Stocks
- Ownership Control: Companies can use treasury stocks to maintain control and prevent dilution of ownership.
- Financial Engineering: These stocks offer flexibility for financial engineering, allowing companies to adjust capital structure and improve financial ratios.
- Employee Benefits: Treasury stocks can be utilised for employee stock-based compensation plans, providing a form of remuneration.
- Market Support: Repurchasing stocks can serve as a way to support stock prices during market downturns, signalling confidence to investors.
- Tax Efficiency: Buybacks can be a tax-efficient way to return value to shareholders compared to dividends.
- Investment Opportunity: Companies may see their own stock as undervalued, presenting an investment opportunity through repurchasing.
- Flexible Dividend Policy: Companies with treasury stocks have more flexibility in managing dividend policies.
- Mergers and Acquisitions: Treasury stocks can be used as a strategic tool in mergers and acquisitions, offering shares as part of a deal.
- Capital Reinvestment: Companies can reinvest excess cash into their own stocks when they believe it is the best use of capital.
Limitations of the Treasury Stocks
There are several advantages to holding treasury stock, but there are also some disadvantages to take into account:
- Liquidity Reduction: Repurchasing shares may result in fewer outstanding shares, which may make it more challenging for investors to buy or sell shares on the market.
- Reduced Cash Flow: Repurchasing shares can be expensive for a corporation and lower the amount of money available for other investments or business ventures.
- Reduced Earnings Per Share: As fewer shares are outstanding, earnings per share may rise, but this may be deceptive if the company isn’t actually growing its earnings.
- Reduced Return on Equity: Treasury stock is not regarded as an asset and does not produce any income, it may lower the company’s return on equity.
- Investors’ Perspective: Share repurchases are seen as an indication that management is optimistic about the company’s prospects. However, if the repurchase is not properly scheduled or carried out, it could convey the wrong message to investors and have a detrimental impact on the stock price.
- Limited Flexibility: The company’s options for employing the shares are limited once they are in the treasury. They don’t provide any income and cannot be sold or put up as security for loans.
- Opportunity Cost: Having treasury shares can result in the company missing out on prospects for growth since the funds used to buy back shares were instead allocated to other investments. Consider the potential disadvantages when analysing a company’s total position in treasury stock.
Strategic Treasury Stock Methods
Through a procedure known as a share buyback or stock repurchase, corporations can purchase their own shares. Companies can do buybacks in a few different ways, including:
- Open Market Purchase: Just like any other investor, companies may buy back shares on the open market. This is the most popular repurchase strategy because it enables businesses to buy shares at the current market price.
- Tender Offer: Businesses have the option to issue a tender offer to shareholders in order to repurchase a set number of shares for a set price. The corporation will buy the shares that are tendered, whether shareholders decide to sell them or not.
- Dutch Auction: Businesses can arrange a Dutch auction, in which they specify a range of prices and ask shareholders to surrender their shares at a price within that range. Following that, the corporation will buy shares at the lowest price required to acquire the required number of shares.
- Privately Negotiated Deals: Businesses can bargain with a particular shareholder or a group of shareholders to buy their shares, typically at a premium over the going rate. Once purchased, shares cease to be outstanding and are kept in the company’s treasury, which means they are no longer owned by stockholders and do not enjoy voting rights. Indian companies are required to include information about their share buybacks in both their annual report and their notice to the stock exchange, including the number of shares to be repurchased, the price, and the length of the buyback.
Conclusion
Treasury stocks serve as a strategic financial tool for companies, providing them with flexibility and opportunities for growth. By repurchasing and holding their own shares, companies can enhance shareholder value, adjust capital structure, and potentially defend against hostile takeovers. While these stocks are not actively traded on the market, they represent a valuable asset for companies to manage their finances and strengthen their overall position in the business landscape.
