Share buybacks, led primarily by IT companies, are set to hit a new record this financial year. As per Prime Database, in the first five months of FY18, at least twenty companies have offered to buy back shares worth Rs 480 billion. Last year, 45 companies announced Rs 344.6 billion worth of buybacks. The trend has been gathering momentum since the government imposed an additional dividend distribution tax (DDT) in the Budget 2016-17.
This fiscal's buybacks include offers from IT giants Wipro and Infosys, which announced buybacks of Rs 110 billion and 130 billion, respectively.
In a buyback, the company purchases its own shares from the stock market and then cancels the shares or keeps them as treasury shares. This whole buyback process reduces the company's outstanding shares. IT companies account for more than 80% of the buybacks in FY18.
Why are IT companies turning to buybacks?
IT firms are going through a difficult phase for a number of reasons including a decline in software exports, pricing issues, and rupee appreciation. The rise in share buybacks could be due to a lack of acquisition opportunities and historically low IT company valuations. Furthermore, these companies have a huge cash pile in their book. In the past, IT companies needed that capital to add people and grow the business. That isn't true anymore. So a share buyback is a healthy way of to reward shareholders.
In India, buybacks make more sense than ever as they've become more tax efficient than dividends. It also helps that a buyback will improve financial ratios such as earnings per share, return on assets, and return on equity.
But investors should not assume buybacks are always good. The reason behind the buyback must be investigated. At the end of the day, an increase in earnings should be more a function of the inherent robustness of the business, as that's what will help it continue to grow at a healthy pace.
Data Source: Prine Database, Mint