Share Buy­backs: Do They Ben­e­fit In­vestors?

Buy­back of shares is trend­ing in IT sec­tor lately. Dr Ruzbeh shares in­ter­est­ing ob­ser­va­tions on price move­ments of such stocks pre and post buy­back and ad­vises whether or not in­vestors should go for them

Dalal Street Investment Journal - - EXPERT SPEAK -

Share buy­back an­nounce­ments tend to ex­cite in­vestors as the buy­back price is usu­ally at a premium com­pared with the mar­ket price pre­vail­ing at that point. One of the re­cent ex­am­ples is In­fosys, which de­clared buy­back at a price of ₹1,150, where the buy­back price had a premium of ~19% over the vol­ume weighted av­er­age mar­ket price.

But is it re­ally ex­cit­ing news? The an­swer ac­tu­ally de­pends from com­pany to com­pany and un­der what cir­cum­stances a par­tic­u­lar com­pany has an­nounced share buy­back. One should study and an­a­lyze the of­fer be­fore ten­der­ing shares.

In sim­ple terms, share buy­back means re­pur­chase of shares by the com­pany. It can hap­pen in three ways a) Ei­ther the com­pany pur­chases its own shares from the

open mar­ket on pro­por­tion­ate bases b) Is­sue a ten­der of­fer c) Ne­go­ti­ate a pri­vate buy­back

BEN­E­FITS TO SHARE­HOLD­ERS:

1. One of the com­mon rea­sons why com­pa­nies go for share buy­back is to boost earn­ings per share (EPS), be­cause share buy­back re­duces out­stand­ing shares in the mar­ket. It is gen­er­ally done when com­pa­nies have sur­plus cash.

2. An­other com­mon rea­son for com­pa­nies to go for a share buy­back is to dis­trib­ute ex­cess cash to share­hold­ers be­cause the ten­der of­fer is usu­ally more than the cur­rent price. This is com­mon prac­tice when the mar­ket price keeps fall­ing and man­age­ment wants to send pos­i­tive sig­nals by buy­ing back the com­pany's shares. A buy­back re­as­sures in­vestors that the com­pany has con­fi­dence in it­self and is de­ter­mined to work to­wards creat­ing value for share­hold­ers.

3. Share buy­back also makes sense for com­pa­nies, be­cause it is more tax-ef­fi­cient. The com­pa­nies can help in­vestor earn a higher tax-free in­come if they dis­trib­ute ex­cess cash us­ing buy­back as com­pared to div­i­dend dis­tri­bu­tion.

In India, a 15 per cent tax is levied on com­pa­nies dis­tribut­ing the div­i­dend. In ad­di­tion, the re­cip­i­ents have to pay 10 per cent more if div­i­dend in­come ex­ceeds ₹10 lakh in a year. In con­trast, there is no tax on long-term gains.

In the present study, we an­a­lyze the his­tor­i­cal per­for­mance of share price near the book clo­sure date of buy­back and the

fi­nan­cial re­turns made thereon.

We se­lected all com­pa­nies which had de­clared buy­back in the last one year (21 Au­gust 2016-21 Au­gust 2017) and are amongst the top 1,000 com­pa­nies based on mar­ket cap­i­tal­i­sa­tion. We ob­tained fi­nan­cial data for 40 com­pa­nies and as­sumed the book clo­sure date as DAY-0. We then ob­tained share price 10-days, 30-days and 90-days prior and post the event date and cal­cu­lated the re­turn for the pe­riod for each of the stocks. Since the book clo­sure date for each com­pany would be dif­fer­ent, event study tech­nique is used where -90 days in­di­cate 90 trad­ing days be­fore the event date. We then ob­tained mean and me­dian re­turns for the said pe­riod. The re­sults are given in Ta­ble 1. In Ta­ble-1, we can very clearly see that max­i­mum mean re­turn is ob­tained in the ‘-90 Days’ bucket (13%). This in­di­cates that share price of com­pa­nies in­creased by 13% dur­ing the 90-day pe­riod be­fore the book clo­sure date. This premium re­duces over the time. Af­ter the book clo­sure date, there is a fall in share price and shares start re­cov­er­ing af­ter 90 days from the book clo­sure date. There is gen­er­ally a time lag be­tween the com­pany declar­ing buy­back, tak­ing share­holder ap­proval and fi­nally declar­ing the book clo­sure date and shares of the com­pa­nies thus ap­pre­ci­ate in this pe­riod.

In­vestor has to an­a­lyze the of­fer con­sid­er­ing he is a long-term or a short-term in­vestor. In case, if he/she is a long-term in­vestor, ten­der­ing shares for a premium of 10-20 per cent is not ad­vis­able. For ex­am­ple, in the case of In­fosys or TCS, the buy­back price was set at a premium of ~18%. If in­vestor is not con­fi­dent of the long-term story, the best strat­egy is to sell all the shares be­fore the book clo­sure date. If the in­vestor is con­fi­dent of growth op­por­tu­nity in the long run, then the best strat­egy is to sell pro­por­tion­ate shares on the buy-back date to take ad­van­tage of price mo­men­tum and hold on to the re­main­ing shares for a longer pe­riod.

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