When a share buyback is good for you?

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Updated: February 27, 2017 7:10:32 PM

The share buyback season is back again. Soon after Cognizant Technology announced its share buyback plan, TCS came out with a Rs 16,000-crore buyback offer, and now the board of Coal India arm NLC is said to have approved a Rs 1,244-crore buyback programme.

According to industry experts, share buybacks are usually announced when a company feels that its shares are undervalued.

The share buyback season is back again. Soon after Cognizant Technology announced its share buyback plan, TCS came out with a Rs 16,000-crore buyback offer, and now the board of Coal India arm NLC is said to have approved a Rs 1,244-crore buyback programme. Infosys is another company which is reportedly mulling over a share buyback worth up to $2.5 billion (Rs 17,000 crore). However, the big question is: Should you go for such offers?

What are share buybacks?
According to industry experts, share buybacks are usually announced when a company feels that its shares are undervalued. “The under valuation may be due to some perceived threats to the industry (that may or may not materialize), growth concerns, and negative sentiments, among others. Buybacks, however, are announced at a premium to the existing market price. The company may buy back the shares through tendering or through market purchase,” says V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services.

Buybacks reduce the supply of the share in the market and thereby facilitate higher price. Buybacks also increase the earnings per share, since the number of shares gets reduced. Increase in EPS, with PE remaining the same, boosts the market price of shares.

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Who opts for buybacks?
Companies with huge cash in books usually resort to buybacks. Buybacks are superior to other forms of shareholder value creation like enhanced dividend distribution. “If a company opts for enhanced dividend distribution, it will result in higher tax outgo in the form of 15% dividend distribution tax. Also, large shareholders will have to pay tax on dividend income beyond Rs 10 lakh. From this perspective, share buyback is a better and more efficient form of enhancing shareholder value,” says Vijayakumar.
There are, however, some restrictions on share buybacks. As per SEBI guidelines, companies are allowed to buy back shares only up to 25 percent of their paid-up capital plus free reserves. This puts a limit to the market price appreciation.

For instance, “in the case of the recently-announced TCS buyback, the amount set apart for buyback is Rs 16,000 crore. But this translates to a potential buyback of only 3 shares out of every 100 shares held. Since the buyback price of Rs 2850 is much higher than the prevailing market price, tendering for share buyback makes sense for investors, even though only around 3 shares out of 100 tendered are likely to be accepted in the buyback,” informs Vijayakumar.

However, in spite of the buyback and attractive valuation, the TCS stock is likely to remain subdued due to the negative sentiments prevailing in the IT industry. Protectionist tendencies from the US, the H1 B visa issue and the headwinds from automation and related issues will remain a drag on the stock for some time to come.

When are buybacks good for you?
Share buybacks become attractive under the following conditions:

* When the buyback is at a big premium over the prevailing market price.

* When the quantity of buyback is big.

Investors should, however, note that buyback offers at a premium to the prevailing price are not always a good buy signal.

“It would not be a prudent strategy to go for a share buyback exclusively on this criteria. Such offers should be considered after doing appropriate research about the company’s fundamentals and the offer price. The offer price should definitely be more than the fair value of the stock and the company should put some premium on the table before such offering,” says Ashish Kapur, CEO, Invest Shoppe.

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The extent of buyback also makes a big difference. Sometimes a buyback which takes away a major part of the public float may be an indication that the promoters would eventually delist the stock. Investors would be better off using the buyback as an exit option in such cases.

Also, in a market condition where there is a huge pessimism about the company’s business prospects, investors who are incurring deep losses should view this as a good exit option to trim down their losses.

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