What is Share Buyback In The Indian Stock market?

If you know anything about the stock market, you might know that one of the biggest advantages of investing in quality companies is the dividend payouts. In simple words, companies distribute some of their earnings to their shareholders by offering them dividends.To give you an example, if a company has announced Rs. 10 dividend and you own 1,000 shares of that company, you will receive a dividend payout of Rs. 10,000. This is one of the top reasons why long-term investors consider the dividend payout history of companies before investing.But in the last few years, buybacks have replaced dividends to some extent as a way to offer cash benefit to the shareholders. At regular intervals, you too, might have heard it in the news or read online that an XYZ company has announced a buyback.What is the meaning of this buyback? Are such buybacks advantageous for existing shareholders? Take a look-

A buyback is exactly what the name suggests. It is a process through which companies listed on stock exchanges repurchase their shares from the open market or existing shareholders.If the share buyback is done from the open market, it is known as open market buyback. In this case, the company is required to mandatorily specify the maximum price at which it wants to repurchase the shares to the stock exchanges.If the company decides to repurchase shares from the shareholder, it is done through a tender offer (TO). If you have shares of a company that announces a buyback through a tender offer, you can sell your shares directly to the company at the specified price within a fixed timeframe.The most recent example of this is the buyback of 5,33,33,333 shares worth Rs. 16,000 crores at Rs. 3,000 per share announced by Tata Consultancy Services Limited (TCS) in December 2020. While the buyback closing date is January 1, 2021, the offer has already been subscribed to 163%.But the whole idea behind listing stocks of a company on an exchange is to raise capital. So, isn't it counter-intuitive for a company to repurchase its shares from the market? Not really, a company decides to buy back its shares from the market or shareholders for several reasons.

• Reducing Capital Costs When you purchase shares of a company, you are actually purchasing an ownership stake in the company. In simple words, if a company has sold its shares to 1,000 people, and it has a single managing owner, the company has a total of 1,001 owners.While IPO (Initial Public Offering) is a way for companies to raise capital for their growth, there are instances when the company does not have a lot of room to grow and has unused cash reserves. This is very common among companies that have expanded to the extent that it dominates the industry.So, carrying all of this unused cash reserve on the balance sheet proves very costly for the company. For instance, shareholders will expect dividends from the company based on its growing balance sheet. Technically, the company ends up paying money just for the privilege of having funds which it is not even using.Spending this reserve on share buyback makes a lot of economic sense as it helps reduce the cost of equity for the company.
• Preserving Stock Price One of the reasons why companies now lay a major emphasis on buybacks over paying dividends is to preserve their stock price. For instance, consider the recent pandemic-fueled sell-off in the Indian markets. When the economic growth of the country slows, it will also impact the financials of the company.The company will reduce or entirely stop paying dividends to the shareholders for preserving cash. As the company will pause dividend payments, investors can consider it a signal to exit their positions. This can cause a severe sell-off in the market, and the price of the stock can fall steeply.In such cases, companies can announce a buyback to try and ensure that the stock prices do not fall as hard as in the scenario above. Note that this is only a strategy adopted by companies. It is not mandatory for any stock's price to rise or fall solely based on dividend or buyback announcements.
• Undervalued Stocks If the company has reasons to believe that its stock price is undervalued, it can decide to buy back some of the shares from the market or shareholders. This is commonly done when bearish sentiments hit the markets or industry. For instance, consider an XYZ company whose stocks fell to record lows during the sell-off in the Indian markets in 2020 due to the pandemic.While the pandemic might have paused the operations and negatively affected its balance sheet, the company is confident of aggressive growth in the following years. In such a scenario, the company can decide to buy back some of its shares at the current lower prices. When the price of their stock rises in the future, it can then sell the same stocks at higher prices.This can be an effective way for companies to increase their equity capital and not issue additional shares. But this endeavour can be risky as a stocks' price can remain low for several months and years.

These are some of the reasons why companies decide to repurchase their shares by announcing buybacks. Now, how do buybacks help existing shareholders? Take a look-

Consider that you have XYZ number of shares of a company that has recently announced a buyback. Why should you sell your shares to the company? The primary reason as to why the shareholders prefer buybacks is profits and tax-efficiency. Taking the same example of TCS, when the buyback issue opened on December 18, 2020, TCS was trading in the range of Rs. 2,850-Rs. 2890.So, this was an excellent opportunity for the shareholders to sell their shares to the company at a price higher than the stock's current trading price.Similarly, when an individual taxpayer receives dividends from a company, the company is entitled to deduct TDS at 7.5% if the dividend is more than Rs. 5,000. The dividend income will also be added to the taxable income of the shareholder and taxed as per their tax slab. In comparison, buyback proves more tax-efficient for the companies as well as the shareholders.

Even the market reputation of the company is impacted when it announces a buyback. Generally, buybacks are considered a positive signal in the eyes of the shareholders. When a company is repurchasing its shares at a higher price, it indicates a feeling of confidence and optimism regarding the company's future potential.It is also seen that buyback announcements attract newer investors to the company. One of the primary reasons for the increased investor interest after the buyback announcement is that such buybacks also affect the company's valuations. To be precise, it helps increase their EPS (Earnings Per Share) and ROE (Return on Equity).

Here is a list of some upcoming share buybacks that have already been announced by the companies-

As we progress through 2021, several other companies are expected to announce buybacks.

Don't apply for a buyback blindly. Analyse the buyback offer before making the decision. To begin with, you should first check the offer price of the buyback. Consider subscribing if the offer price is significantly higher than the current market price of the stock.Also, if the buyback offer is announced through a tender offer, check if the company promoters are also subscribing to the buyback. If yes, this is generally considered a positive signal for the future prospects of the stock price. Do consider the tax aspect to ensure that subscribing to the buyback is a more tax-efficient option than holding the shares and earning dividends.

While buybacks are generally seen as a positive signal for a company, there is no saying where the stock prices will be in the future. Like most things related to the stock market, the future prospects of any company, no matter how big or small, is never certain.Irrespective of whether you are holding shares of a company that has announced a buyback or want to invest in the company as a new investor, be careful with your decision as it could have significant consequences. Consider professional assistance if you are new to the market and unable to make the decision.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.