Stock Buyback – A gift for shareholders
Stock buyback also known as stock repurchase is considered as a gift for shareholders. Its highly rewarding because of its implications on the market value of the shares and the return ratios. It is another option apart from dividends where the company uses the cash on books to reward shareholders. A growing company with increasing demand and opportunities can use the cash for capex (setting up new plants or factories), acquistions (in the same or adjacent industries). Whereas, a mature or a niche company might find it difficult to grow via capex or acquisitions because the industry might be slowing down. In such a scenario rather than investing in new unknown industries, a stock buyback can give better returns to the shareholders. Also, companies can take this decision when they think the stock is undervalued.
Financial Implications of Buyback
A company can buy shares directly from the market or offer its shareholders the option of tendering their shares directly to the company at a fixed price (higher than the market price). In either cases, a share buyback reduces the number of shares outstanding. After buyback, the shares bought by the company are cancelled or held as treasury shares. Hence, these would no longer be held publicly and won’t be a part of outstanding shares. With lesser number of shares outstanding, the earnings per share (EPS) would be increased. Given that the EPS suddenly increases, there are high chances that the market value of the share is increased as well. Also, a buyback reduces the total assets of the business. Hence, there is an improvement in return on assets and return on equity for the business. If the company has been paying dividends, the stockholders are expected to receive larger dividends as the number of shares get reduced
An Example -TCS and Cochin Shipyard Buyback
Tata Consultancy Services Ltd announced to buy back 7,61,90,476 equity shares (around 1.99% of the shares outstanding) at a fixed price 2100 Rs. Post buyback, the outstanding shares were reduced by approx. 2% and this led to an increase of EPS by more than 2%. It also led to a 2% improvement in the Return of Equity as well. The stock price reflected these improvements and moved from 1800 to 2255 Rs.
Cochin Shipyard has been trading below its listing price from the past quarter. The stock has not performed well despite good growth numbers by the company. Interestingly, the company holds 3000 crores+ Rs in cash which is equivalent to approx 57% of the total market capitalization. The company is planning to invest a part of this cash in stock buyback. The remaining cash would be invested in planned dock expansion. Buying back the stock also shows company’s confidence in the future prospects.
Cons of a buyback
Though there are many positives associated with a buyback, there are few negatives as well. A share buyback gives an impression that the company does not have other profitable growth opportunities to deploy cash. This might not look attractive to investors looking for fast growth in revenue and earnings. A share buyback also reduces the cash with the company. This can be a problem going forward if there is an economic downturn or the company faces any financial issues. But, if the cash is allocated wisely for the buyback leaving ample amount for other growth opportunities and backup, then stock buyback is an excellent way to create value for shareholders. In most cases, the stock price tends to appreciate post the announcements.
Due to the recent slump in the market, many companies are leveraging the cash on their books to buyback the shares. Firms like Mphasis, L&T, Nalco, NLC India, Coal India, BHEL and Cochin Shipyard are planning to come out with their buybacks.
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Disclaimer: I am not a SEBI registered analyst and not advising anyone to buy. The purpose of this article is to share my viewpoint about fundamentals and the future prospects of the company. So, please do not consider this as an investment tip. Talk to your financial advisor before taking any investing call.
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Hi, I am Azhar, a management graduate from IIM Bangalore. I work as a manager in a FMCG firm. From college days, I had a lot of interest in equity markets. My passion for teaching led me to setup this site to educate retail investors about stock markets investments. Looking forward to learn and grow with you. Happy investing !!