Share buyback: Is the move always worth it? (2024)

While experts are generally positive about share buyback, there are some tough decisions that the management needs to factor in during all stages of the buyback.

“A buyback (of issued shares) is good for investors as well as for the company," says Shrikant Chouhan, Head of Equity Research (Retail), Kotak Securities, who feels that the buyback would be better through tender route instead of open market as then it adds more value for the investor.

“Buyback news is good news for retail investors because it means the promoter is raising their stake and trusting their business," says Kush Ghodasara, Independent Analyst (CMT).

Buyback is when a company repurchases its own shares from the market, indicating that the company believes its shares are undervalued. This can signal confidence in the company's future and potentially boost shareholder value.

But now an investor must analyse the nuances of the buyback, whether it is worth it and the motives of the company in the buyback.

“A company goes for the buyback of shares if the board feels that the stock is undervalued or, in some cases, the company does not have any productive use of the free cash on its books and would prefer to return it and reward the shareholders through buyback of shares rather than dividend payouts," says Gaurav Dua, Head - Capital Market Strategy at Sharekhan by BNP Paribas.

The benefits of a buyback include an increase in earnings per share (EPS) since the same earnings are divided among fewer shares, potentially boosting the stock price. This can lead to higher returns for investors who hold onto their shares post buyback.

A buyback can be in two types. Tender offer or open market offer.

In the tender option, investors have the option to submit a request to sell a percentage or all shares they hold at a price higher than the current market price. The share buyback price is pre-decided by the company. For every share tendered, investors benefit.

In the open market option the company buys back shares from the open market over an extended period.

In the tender offer, investors receive the benefit, as they can sell their shares at a higher price. In the market offer, investors don't benefit, as when an investor places a sell order, there is no clarity on whether shares are accepted under a buyback or sold in the open market.

To avoid this, SEBI has decided that it will eventually phase out the second option. For now, it has made changes for the companies that carry out the buyback via the open market route, according to a research note by icicidirect.com.

“I would prefer the tender route instead of open market offer as then it adds more value for the investor," says Chouhan.

But is a buyback good?

“There are potential downsides to consider," says S Ravi, former Chairman of BSE and Managing Partner of Ravi Ranjan and Co. “If the company funds the buyback through debt, it could increase its financial leverage, making it riskier for investors. So please study where the company’s management is getting the money from to fund the buyback."

Also, if the management's judgment is flawed and the stock price does not perform as expected, investors may face losses.

If the company is doing well and there are no options for new acquisitions, it is the best way of using the cash of the company, notes Chouhan. Generally, technology companies opt for buyback or those companies where the ongoing business is doing well and they can increase the return on equity via the buyback.

“A Buyback may be considered good only if the price band of buyback offered by the company is fairly on the higher side from the current market price," says Puneet Maheshwari, Director, Upstox. Suppose the current market price of the stock is Rs. 100 and the company is offering buyback price of Rs. 150.

There is, however, a catch here. It may not be necessary that the number of shares which the client applies to, will all be bought back. The companies generally in the offer provide the number of shares it would buy back, so majorly the buyback would happen of only proportionate number of shares that one applies.

The movement of a company's shares typically follows a discernible pattern both before and after a buyback, according to experts.

Before a buyback announcement, the share price often experiences upward momentum as investors anticipate the company's intention to repurchase its own shares. This anticipation can be driven by the perception that the company considers its shares to be undervalued, leading to increased demand and a rise in share prices.

Following the buyback, there is often a short-term boost in share prices. The reduction in the number of outstanding shares due to the repurchase increases the earnings per share (EPS) for existing shareholders, making the stock relatively more attractive. Additionally, the buyback signals confidence from the company's management in its future prospects, which can further instill investor confidence and drive share prices higher.

However, the long-term effects of buybacks on share prices are more nuanced. If the company's decision to buy back shares is perceived as a lack of investment opportunities or a sign that it is not using its resources optimally, it may lead to a negative market sentiment, causing the share price to stagnate or even decline in the long run.

While buybacks can initially boost share prices due to increased demand and positive investor sentiment, their long-term impact is influenced by various factors, including the company's financial performance, market conditions, and investor perception of the buyback's intent and implications.

Which brings us to the point that we need to analyse both the company’s motives as well as the management’s doctrine in the buyback.

“Very importantly, investors should consider fundamental factors like growth outlook and valuations. So, as an investor, you need to take various factors into account and not simply chase any stock just on the news of buyback," says Dua.

“I advice that before any retail investor takes any decision on a buyback, he/she must consult a financial advisor to check the company's future prospects. Understanding the company's financial health and growth potential is crucial before making any investment decision," says Ghodasara.

Buyback and your taxes

The tax treatment continues to be similar to normal stock trading (Short Term Capital Gain and Long Term Capital Gain - STCG or LTCG).

The buyback price to be considered as the selling price minus the price at which the stock is bought will provide for the profit / loss that you make.

If the holding period of the stock is less than 1 year then it would be considered as Short team Capital Gain / Loss and if the holding period is greater than 1 year then it would be considered as Long Term Capital Gain / Loss.

STCG are chargeable at 15% if STT is paid on it else as per the income slab of the investor + Cess. LTCG is chargeable at 10% if the amount of gain is more than Rs. 1 lakh else it is exempt.

Manik Kumar Malakar is a personal finance writer.

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Published: 26 Oct 2023, 12:28 PM IST