Shareholders get excited about the news of share buyback, (As Happened with TCS) but have you ever thought why a Company would give away its capital margins back to the shareholders? It may seem little counter-intuitive as the capital is accumulated at first by selling equity and preference shares. Then why would a company buy back its own shares again? Before jumping into share buyback trades, an investor should judge and analyze the reasons behind the repurchase of the shares by a company.
Companies might choose any of these three ways to repurchase their shares:
1. Buyback from the open market
2. Private Buyback
3. By issuing a tender offer.
Common Reason behind Share Buy backs
Undervaluation: Due to market trend, Volatility or Risk off sentiment, there might be an undervaluation of the shares as investors sell their holding to secure their profit. In such case, Issuing company might choose to buy back some part of the shares at the market price or at a premium and when market gets normal the shares are issued again. This way a company might increase its capital by taking the advantage of undervaluation of stock prices.
No Growth in Sight: It is mainly related to IT industry, when the growth perspective is slow and if the company has huge cash and cash equivalents they may go for a nominal buybacks. (Recent case with TCS) IT Company’s do a buyback of their shares in large quantities to boost their EPS as the normal growth rate of the IT companies revolves around 4-5%. To boost their valuations and Share prices, Firms may opt for a buyback.
To Increase the EPS: EPS or Earning per share is one of a key indicator for calculating company’s growth. Share buybacks can easily boost the percentage of EPS. It is because share buyback means repurchasing of shares from the shareholder, reducing the outstanding shares in the market thereby increasing the EPS.
Tax Benefit: The dividend paying companies has to pay 15% tax and the shareholder who receives the dividend has to pay 10% tax if the dividend per annum exceeds the capital of 10 lacs. But incase of long term gains from share, there is no such tax. So, keeping this factor in mind, share buyback is a good option to wave off taxes. Companies who have enormous cash reserves and paying dividends in a regular manner may find share buyback as advantageous because of the tax benefit and as an alternative to the payment of dividends.
Benefits the Shareholders: When the company has an excess of cash in hand, it might want to go for a share buyback to distribute the excess cash amongst the shareholders. The premium price offered for share buybacks benefits the shareholders as they get to sell their holdings at a higher price. It is also done to safeguard the investor’s interest in the company during a bear market or when the market price of a particular share is decreasing rapidly.
Conclusion
Markets are very sensitive to buybacks. In the recent TCS buyback, 13.7% premium was offered over the closing price on Monday. If the investor has a long-term vision then going for buyback option may not be suitable, since he could only earn the premium offered by the company (Only a Short term gain.) A Trader with a short-term strategy for TCS shares could’ve reaped profits out of this buyback. Otherwise there is no sense on selling the shares if you are a long-term investor.
If you are thinking about selling your shares in a buyback, before you do so, analyze the reason behind the buyback program and analyze your plan about the stock whether you’re holding it for long term or short term.
