A share buyback occurs when a company purchases some of its shares in the open market and retires these outstanding shares. This can be a great thing for shareholders because after the share buyback, they each will own a bigger portion of the company, and therefore a bigger portion of its cash flow and earnings.
Big technology companies such as Infosys, TCS, Wipro, Tech Mahindra & HCL Tech & cash rich PSU Companies like L&T (buyback stalled by SEBI), Coal India, NMDC etc have in the recent past preferred taking the buyback route. This helps in meeting two purposes, firstly rewarding shareholders and secondly utilizing free cash available. These Companies generate a good amount of free cash every year and in order to maintain healthy return ratios, they keep a generous payout ratio either in the form of dividends or buybacks. Normally, an IT company or PSU mining & mineral companies do not have major capital expenditure and so there is no prudent reason to hold back cash and earn meager interest income. Data suggest that based on FY18 balance sheet, 9 out of 10 Nifty IT companies have quick ratio of more than 2, thus indicating high liquidity in their balance sheet.
Currently most cash rich companies prefer to take the buyback route instead of paying higher dividends due to higher taxes levied on dividend incomes. Dividend payment attracts a 15% dividend distribution tax (DDT) and also individuals who receive dividend income more than Rs 10 lakhs per year pay a dividend tax of 10%. Since a lot of HNIs & public institutions hold a high value of shares, a buyback would help these institutions to save some taxes.
In addition share buyback leads the rise in EPS, return on shareholders’ fund ratio of such companies & helps them in commanding greater value for their shares in market indicating effective utilization of cash available in balance sheet.
Currently state-run firms, including Coal India, NHPC, NMDC, ONGC, IOCL, Oil India etc. are on a buying spree to help the government, their biggest shareholder, meet its asset-sale target. Buybacks allow cash rich state firms to return excess funds to the government in a tax-efficient manner.
Declining share values and a slowing global economy has helped accelerate the trend of buybacks. Software exporters, which get a bulk of their revenue from abroad, are leading the pack as shrinking client budgets leave them with fewer opportunities to use their cash.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 10 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’