What Do Buybacks Mean for shareholders?

Tue, 21 Feb Pre-Open

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The number of companies going for share buybacks has been on the rise lately. The trend has picked pace especially after Union Budget 2016-17, where the government imposed an additional Dividend Distribution Tax (DDT). Many companies went on to declare dividends after the announcement. And those who missed the bus are now taking the share buyback route.

In a buyback, the company purchases its own shares from the stock market. Subsequently, it cancels them or keeps them as treasury shares. The whole buyback process results in the reduction of company's outstanding shares.

A buyback could mean the company has adequate cash to buy its own shares and is willing to reward its shareholders. It could also mean an improvement in financial ratios such as price to earnings, return on assets, and return on equity.

Apart from the above, buybacks make a lot of sense for companies now as they've turned tax efficient over dividends in India.

Many companies have already taken the plunge, while some are in the process. And going by the momentum, more could follow in the coming days...

So what should long-term investors do?

There's no doubt that tendering a part of your shares in a buyback could be a tempting proposition, especially if the buyback price is higher than the market price.

However, it's important to understand that buybacks reduce the outstanding number of shares. Thus, the shareholders who don't tender their shares will end up with a bigger piece of the pie.

Doing nothing during a buyback may not be satisfying to many investors. Receiving cash may seem to be a better option.

But remember, if you really are a long-term investor, buybacks will increase the value of your existing shares. The reduced number of outstanding shares will boost per share earnings as well as RoE. And in the long run, these two measures matter more than anything else.

In all, we believe investors should consider buybacks on a case-by-case basis.

Buybacks can be seen as a healthy development. However, that should be only one of the data points investors should look at. Ultimately, it boils down to management integrity, the company's moat as well as the health of the company's balance sheet.

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