Stock market: Should you accept a share buyback offer?

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October 28, 2020 1:30 AM

Check the price movement of the share just before the buyback is announced. If there has been a steep rise in the share price, then investors must be cautious

In a share buyback, a company buys its own shares from the market because it wants to reduce its number of shares available in the open market.

Many companies that have large surplus cash on books are opting for buyback of shares. The boards of IT majors such as TCS and Wipro have announced share buyback of Rs 16,000 crore and Rs 9,500 crore, respectively. In 2018 too, TCS had undertaken a share buyback programme worth up to rs 16,000 crore as part of its long-term capital allocation policy of returning excess cash to shareholders.

In a share buyback, a company buys its own shares from the market because it wants to reduce its number of shares available in the open market. There can be many reasons such as the company wants to reduce the number of shares in the open market, boost share price in the open market and improve the shareholders’ values. For shareholders, the benefit is that the offer is made at a price that is at a premium to the market price of the stock to make it attractive. Such a move improves the confidence of investors. For instance, TCS proposed to buy back shares at Rs 3,000 per share, which is at a premium to the closing price of `2,737 on the day of the announcement (October 7).

Similarly, Wipro will buy each share at a price of Rs 400, at a premium to the closing price of Rs 375.75 on October 13. Earlier, companies such as Sun Pharma, Supreme Petrochem, Emami, Dalmia Cement and Granules India Ltd had announced share buyback.

Returning surplus cash
Analysts say buyback is an efficient form of returning surplus cash to the shareholders of the company to increase the overall returns of the shareholders. Returning excess cash makes sense when the stock is selling for less than its conservatively calculated intrinsic value. In other words, a company’s management should take a rational view of its future business prospects and its stock price. Unless the stock is clearly undervalued, a buyback is the wrong way to go.

When a company goes for stock buybacks, it shows that the company has sufficient cash on hand. So, returning excess cash signals to the investors that the organisation feels that it is better to return the cash to shareholders rather than reinvesting in alternative assets.

There are two types of buybacks—open tender offers from the existing shareholders on a proportionate basis and open market through stock exchanges. Most companies prefer to go through the open market route. In buybacks which are done through the tender offer route, 15% of the number of shares to be bought back is reserved for the small shareholders, whose market value as on record date is not more than Rs 2 lakh. Analysts say that buyback helps in improving return on equity because of the reduction in the equity base. The process leads to long-term increase in shareholders’ value.

Points for investors
Investors must analyse the price movement of the share just before the buyback is announced. If there is a steep rise in the share price of the company, then investors must be cautious. Individual investors must look at the size of the buyback offer, the price and the duration of the offer. If the buyback size is too small compared with the overall market capitalisation of the company, the impact on the share price could be very insignificant.

Investors must also look at the debt-equity ratio to understand the fundamentals of the company. If the If debt level is higher than the industry average, it means that the company’s free cash flow in the future is going to be tight. Investors prefer buybacks over dividends, as these are more tax-efficient. The abolishment of Dividend Distribution Tax (DDT) in FY21 resulted in an increase in tax incidence in the hands of individual resident shareholders, which has made buybacks more attractive.

BUYBACK OFFERS
For shareholders, the benefit is that the offer is made at a price that is at a premium to the market price of the stock
Buyback is an efficient form of returning surplus cash to the shareholders of the company to increase the overall returns of the shareholders
Investors prefer buybacks over dividends, as these are more tax-efficient
Investors must look at the size of the buyback offer, the price and the duration of the offer before taking a decision

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