TCS' Big Buyback Plan Cements My Prediction

Markets are excited about yet another big buyback. TCS's buyback will be the fourth in the first quarter of this fiscal.

In 2017-18, the number of buyback offers were at an all-time high. Never, in the last two decades, had Indian markets seen fifty-nine companies announcing buyback plans.

But what is truly surprising is that unlike in the past, the buybacks this time seem skewed in favour of short term investors rather than long term ones.

Look at the history of buybacks since 2002. Logically promoters should offer to buyback shares at a premium when the stock is undervalued. And this logic held true until recently. The number of buybacks peaked when market valuations were low. And in times of peak valuations (like 2007 and 2011), promoters refrained from doing so.

But not this time. The trend of rising buybacks in the last two years, resembles the sentiment of a momentum investor. The appetite to buy shares kept rising with the rising markets. And the latest buybacks of stocks like TCS and MOIL, came at a time, when neither the broader index (Sensex) nor the stocks themselves, are undervalued.

Who Benefits from Such Buybacks?

To put this is in context, here is what you must understand about buybacks...

One of the criteria by which we judge managements is their capital allocation skills. In other words..how they deal with excess capital. Markets reward businesses which return surplus capital to their investors and punish businesses which retain surplus capital. That is why companies with consistently high dividend payout ratios typically trade at a premium.

There are only two ways in which companies can return excess capital. Either they pay dividends or buyback shares. Before share buybacks were allowed, the only way to return surplus capital to investors was through dividends. Share buybacks, then, should simply be viewed as one more way of returning excess capital to investors. Sometimes it will make sense to return excess capital though dividends, and sometimes it will make sense, instead, to buy back shares.

When a company's stock is undervalued, buyback makes more sense than dividends. Since the shares bought back are immediately cancelled, the buyback increases the fair value of the outstanding shares. When a stock is fairly valued, or over-valued, then dividends may make more sense than a buyback.

But then, economic rationale, is not the only reason why managements decide to buy back shares. Some companies may buy back their shares, even though they are overvalued. What makes economic sense for the promoters, may not make economic sense for other investors. Doing so results in a transfer of wealth from shareholders who do not sell their shares to the company at the overvalued price to the shareholders who do.

In the long run, however, investors, typically do not favour companies that constantly buy back their shares at inflated prices.

We do not know, if markets will penalize stocks like TCS and MOIL for being imprudent with cash and buybacks, over the long term.

But for now, this is certainly a tactic to temporarily appease investors.

Like I wrote in the Wrapup recently, cash rich companies will increasingly resort to either big dividends or big buybacks or both, in the coming months. In the hope that investors will continue to stay appeased with the steady income, if not the capital gains.

Buybacks are now relatively more tax efficient than dividend payouts. And so, this is yet another reason for companies to choose the former.

As a shareholder in cash rich companies, you should not only be wary of expensive buybacks. But if possible use it to your advantage to rake in some cash.

It's a matter of time before you get to use the cash for buying stocks, you've always wanted to, at attractive bargains.

Chart of the Day

Since we spoke of big buybacks, we should also be talking of the big dividend payouts. After all, this is yet another tool that companies should ideally use to distribute surplus cash. Probably more often than buybacks. But cash rich companies often pay big dividends to temporarily appease shareholders, even when the core business is under stress.

If we look at stocks with the best dividend yield (to keep valuations in context), it's the public-sector entities that continue to pay the most. And this is more likely a result of the government's need for cash than because of the companies' ability to pay out.

The dividend yields of private sector companies hardly look as attractive at current valuations.

Big Dividend Yields - Restricted to PSUs

Warm regards,


Tanushree Banerjee (Research Analyst)
Editor, The 5 Minute WrapUp

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