Share Buybacks: Do They Benefit Investors?

Share Buybacks: Do They Benefit Investors?

Buyback of shares is trending in IT sector lately. Dr Ruzbeh shares interesting observations on price movements of such stocks pre and post buyback and advises whether or not investors should go for them

Share buyback announcements tend to excite investors as the buyback price is usually at a premium compared with the market price prevailing at that point. One of the recent examples is Infosys, which declared buyback at a price of Rs1,150, where the buyback price had a premium of ~19% over the volume weighted average market price. 

But is it really exciting news? The answer actually depends from company to company and under what circumstances a particular company has announced share buyback. One should study and analyze the offer before tendering shares. 

In simple terms, share buyback means repurchase of shares by the company. It can happen in three ways -
a) Either the company purchases its own shares from the open market on proportionate bases
b) Issue a tender offer
c) Negotiate a private buyback 

BENEFITS TO SHAREHOLDERS: 

1. One of the common reasons why companies go for share buyback is to boost earnings per share (EPS), because share buyback reduces outstanding shares in the market. It is generally done when companies have surplus cash. 

2. Another common reason for companies to go for a share buyback is to distribute excess cash to shareholders because the tender offer is usually more than the current price. This is common practice when the market price keeps falling and management wants to send positive signals by buying back the company's shares. A buyback reassures investors that the company has confidence in itself and is determined to work towards creating value for shareholders. 

3. Share buyback also makes sense for companies, because it is more tax-efficient. The companies can help investor earn a higher tax-free income if they distribute excess cash using buyback as compared to dividend distribution. 

In India, a 15 per cent tax is levied on companies distributing the dividend. In addition, the recipients have to pay 10 per cent more if dividend income exceeds Rs10 lakh in a year. In contrast, there is no tax on long-term gains. 

In the present study, we analyze the historical performance of share price near the book closure date of buyback and the financial returns made thereon. 

We selected all companies which had declared buyback in the last one year (21 August 2016-21 August 2017) and are amongst the top 1,000 companies based on market capitalisation. We obtained financial data for 40 companies and assumed the book closure date as DAY-0. We then obtained share price 10-days, 30-days and 90-days prior and post the event date and calculated the return for the period for each of the stocks. Since the book closure date for each company would be different, event study technique is used where -90 days indicate 90 trading days before the event date. We then obtained mean and median returns for the said period. The results are given in Table 1

.In Table-1, we can very clearly see that maximum mean return is obtained in the ‘-90 Days’ bucket (13%). This indicates that share price of companies increased by 13% during the 90-day period before the book closure date. This premium reduces over the time. After the book closure date, there is a fall in share price and shares start recovering after 90 days from the book closure date. There is generally a time lag between the company declaring buyback, taking shareholder approval and finally declaring the book closure date and shares of the companies thus appreciate in this period. 

Investor has to analyze the offer considering he is a long-term or a short-term investor. In case, if he/she is a long-term investor, tendering shares for a premium of 10-20 per cent is not advisable. For example, in the case of Infosys or TCS, the buyback price was set at a premium of ~18%. If investor is not confident of the long-term story, the best strategy is to sell all the shares before the book closure date. If the investor is confident of growth opportunity in the long run, then the best strategy is to sell proportionate shares on the buy-back date to take advantage of price momentum and hold on to the remaining shares for a longer period.