Share Buyback Explained: Definition, Advantages, and Consequences for Investors
Recently, a number of Indian companies, such as TCS, Infosys, Wipro, and Bajaj Auto, have been in the news for share buybacks, which seem to have caught the attention of retail investors. But what does share buyback entail and what makes these companies pursue it? Is it beneficial or harmful for investors?
In this blog, we will walk you through the definition of share buyback, its benefits, share buyback procedure, the reasons behind companies opting for it along with things that need attention from the investors. Let's move forward!
Concept of Share Buyback
A buyback or stock repurchase occurs when a corporation decides to repurchase its shares from current investors in the market. A repurchase offer is made at a premium and in most cases, these shares are sold at a price higher than the market price.
The shares bought back may be extinguished or held as treasury stock. In both scenarios, the overall quantity of shares available in the stock market is decreased. This frequently leads to an increase in economists’ predicted earnings per share (EPS) as it is generated by fewer shares and usually increases the share price.
Why Do Businesses Prefer Share Buybacks?
Corporate share repurchases can be motivated by diverse causes. These motivations will be discussed below:
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To Relinquish Excess Cash To The Shareholders
In case a firm is holding cash with no major investment plans, the firm may use this money to repurchase shares instead of capital dividends.
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To Enhance Corporate Ratios
In the case of a share repurchase, the number of shares in circulation is reduced. This increases important ratios such as EPS (Earnings per Share), Return on Equity (ROE) and even the Price to Earnings (P/E) ratio, improving the picture of the firm's finances.
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To Exhibit Firm’s Derivative Value
Corporations utilise buyback for the purpose of demonstrating their belief that quoted value is less than the price. This kind of action demonstrates their confidence in the corporation or its earnings.
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To Thwart Unsolicited Company Takeover
Decreasing the number of freely circulating shares in the stock market prevents an investor or company from easily acquiring a majority stake and taking control; thus preventing an easy takeover.
Varieties of Share Buyback in India
According to the SEBI regulations, buyback of shares in India can be carried out through two primary methods:
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Offer to Tender
In this practice, the company purchases a specific number of shares from the shareholders for a set price. Shareholders have the option to either accept or reject the offer. In cases where there are more applicants than shares, a certain percentage of the shares are accepted proportionately.
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Purchase in an Open Market
In this instance, the company purchases shares from the public market over a specified duration. There is no set price of purchase, as purchases are made through the stock exchange at market prices.
What Impact does Share Buyback Have on the Investor?
In order to have a better understanding of the effects of share buyback on investors, particularly retail investors, it is best to explore it through reasons:
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Anticipated Capital Profits
These events also help increase profits for those selling their shares because buybacks are typically offered at a premium.
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Increased Remaining Shares Value
Due to buybacks, the total shares in circulation are reduced. With improved business performance, surplus in EPS and increased market confidence, the value consequently increases.
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Tax Efficiency
Buybacks may be more tax efficient than dividends in some cases since dividends are subject to Dividend Distribution Tax (DDT), while capital gains on buybacks are taxed at a lower rate depending on the holding period.
Recent Examples of Share Buybacks in India
Let's go through recent notable instances of share buybacks that attracted public interest:
TCS Share Buyback (2023): Tata Consultancy Services declared a ₹16,000 crore buyback at the market price of ₹4,500. This was above the market price at the time.
Wipro Share Buyback (2023): Wipro initiated a ₹12,000 crore buyback through a tender offer.
Bajaj Auto Share Buyback (2024): Bajaj Auto declared a buyback plan worth ₹4,000 crore. This illustrates the strong cash position of the company.
These instances demonstrate the value that major companies are now offering to shareholders while enhancing their financial image.
Advantages of Share Buyback for Companies
Companies also gain several benefits from conducting share buybacks:
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Better Utilisation of Idle Funds
Excess cash with no outflow expansion plans? Smart companies utilise those funds by executing a buyback.
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Boosts Shareholder Value
By lowering the number of shares, the earnings will get distributed among fewer shareholders, which increases the value of every share, thereby increasing shareholder value.
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Control Dilution Management
The granting of stock options leads to dilution as employees are given equity. Buybacks help limit the dilution and sustain the percentage ownership of promoters and shareholders set to benefit.
Risks or Drawbacks of Share Buybacks
As much as buybacks offer numerous advantages, there are a few which should serve as caution for both investors and companies:
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Short-Term Surge
In certain scenarios, the sole announcement of a buyback tends to increase the stock price, albeit for a very limited time. If there’s no value, the stock is bound to take a hit down the line.
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Abuse by Executives
It is observed that in the short term, buybacks tend to raise stock prices and financial ratios; many do it while bypassing the best interests of the firm in the long run.
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Forgone Reinvestment Opportunities
The capital allocated to buybacks can instead be used to fund other value-generating activities such as expanding the business, conducting necessary research and development, or servicing debt obligations.
Should Retail Investors Participate in Share Buybacks?
This question is often asked. Consider the following points to assist in making a decision:
Investors who do not foresee long-term growth for the business/stock but believe the purchase price significantly exceeds market value may decide to sell.
If the firm demonstrates a sound business model and the investor has more of a long-term outlook, it may be favourable to postpone selling to benefit from increased equity value down the line.
Always monitor the acceptance ratio, particularly for the tender offer method, to gauge how many of your shares are likely to be accepted.
How can one apply for a share buyback in India?
If a company intends to buy back shares via the tender offer method, this is how you make an application:
You will be sent an offer letter along with an application form.
Complete the form and submit it via your broker or trading platform before the deadline.
When the offer is accepted, the shares will be removed from your demat account and payment credited to your bank account.
In the open market approach, there is no application process. You can sell your shares on the market and if the company is actively buying, you may be chosen automatically.
Conclusion: Is share buyback a positive indicator?
In most scenarios, share buybacks are considered to be a positive strategy, signalling that the company is confident about its business and desires to reward shareholders. Still, the analysis has to be done on the company’s fundamentals, price of the buyback, and growth outlook before making a decision.
As an investor, do not get swept up in the excitement without reason. Analyse the details closely, know your objectives particularly in the context of the buyback offer, and only then decide.
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Frequently Asked Questions (FAQs)
Q1. Is share buyback taxable in India?
Yes. In the case of retail investors, profit from buyback is considered capital gain. However, in a tender offer, the company does pay buyback tax and the sum received by the investor is exempt from tax as per Section 10(34A).
Q2. Can I sell all my shares in a buyback?
You can offer all of your shares, however, the number that is accepted depends on the acceptance ratio, specifically in a tender offer.
Q3. Is share buyback better than dividend?
It depends. In many cases, buybacks are more tax efficient for the investors compared to dividends which provide a steady stream of income. However, for long-term investors, buybacks might be preferable and convert to capital gains.
Equipped with the knowledge of a buyback, its reason, and consequences, one can invest wisely. Remember to pay attention to the headlines and always be vigilant for announcements made by corporations.
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