FY18-19 is the third fiscal year in a row where buyback announcements were above 0.20 percent of the total market capitalisation of Indian stocks. It is also the third consecutive year where close to 50 companies announced a buyback.
The 2016 Budget created a favourable environment for companies to buy back their shares over handing out dividends by introducing taxes on dividend income above Rs 10 lakh received by an individual.
As the trend continues to grow, it becomes difficult for retail investors to decide whether to participate in a buyback or not.
We point out the basic details of the buyback announcement that helps in deciding whether to participate or not.
Cash for Buyback: A retail investor should analyse how fast a company can generate the same surplus cash it used for conducting the buyback. This is very important for future growth and buyback continuation of the company. Only participate in buyback where the company can recover the cash quickly.
Percentage of Market-Capitalisation: It is an important aspect as it defines whether the buyback should be treated as a replacement of dividend or an actual buyback. Any buyback below, 5-6 percent of the market capitalisation should be considered as a replacement of dividend since it is more tax efficient post the 2016 Budget.
Tender or Open Market: Tender route is more favourable as the price and the minimum quantity of shares that can be tendered is fixed. Whereas in open market buybacks, the maximum price is provided with no definitive way of selling the buyback shares. Also, the buyback is at market price.
Promoter Participation: Another important aspect as the percentage calculation changes in accordance to this factor. Promoters generally own more than 51 percent of the shares, their non-participation makes the buyback more lucrative to retail investors as acceptance ration increases and can be considered as a step to boost investor confidence.
EPS Change: Buyback of shares impacts the earning per share calculation as it reduces the total number of shares which, in turn, increases the EPS. However, reduction in cash due to buyback will impact the earnings as other incomes of the company is affected. As an investor, you need to know the net impact of the decision.
The aforementioned factors should be considered before you decided whether you should particpate in the buyback or not. Even though buybacks are another method to provide investors with a cash payout, buying for the sole purpose of participating in the buyback is tricky.
As India buyback announcement has twelve months interval, investing in a company for just buyback is not a lucrative investment decision. Thus, the fundamentals of the company announcing buyback should be considered first.
The author is Founder & President (Research) at Target Investing.
