Why do Companies Buy Back Shares?

Tech titans like Alphabet (Google's parent company) and Apple are dominating headlines with eye-watering, multi-billion dollar share repurchases.

Apple just smashed records with the largest stock buyback in US history - a whopping US$ 110 billion (bn) earmarked to buy back its own shares, according to their Q1 2024 earnings report.

This move cements their position as the king of buybacks, holding 6 of the top repurchases.

But the trend isn't just confined to Silicon Valley. A similar buyback frenzy has gripped India's Dalal Street in recent months. Over 14 companies have either announced or completed stock repurchases, all within the first five months of 2024.

Despite their popularity, buybacks are surprisingly divisive among investors. Some see them as a wasteful use of corporate cash, while others view them as a prime way to deliver tax-friendly returns to shareholders.

Both sides have compelling arguments, but who ultimately has the upper hand? Let's delve deeper into the world of stock buybacks and explore the pros and cons of this practice.

What is a Share Buyback?

Share or stock buyback is the practice where companies decide to purchase their own shares from their shareholders either through a tender offer or through an open market.

In such a situation, the price of the shares is higher than the prevailing market price.

A company may do this to return money to shareholders that it doesn't need to fund its operations and to make other investments.

In a stock buyback, a company purchases shares on the secondary market from any investors who want to sell.

Shareholders are under no obligation to sell their stock back to the company. Also a stock buyback doesn't target any specific group of holders. It's open to anybody.

Companies usually carry out buybacks through open-market operations.

This is by far the most common buyback mechanism. Companies that implement these kinds of buybacks announce in a press release the total number of shares authorized for potential repurchase but make no commitments about price, timing, or even execution.

The other methods of buyback include fixed-price tender offers and auction-based tender offers.

Why Companies Buyback Shares?

There may be several reasons why a company opts for a stock buyback. But what exactly motivates companies to buy back their own stock?

The answer, as with many financial matters, is a complex dance between creating value for shareholders and potential strategic manoeuvring.

However, here are the most common motivations behind stock buybacks:

Creating Shareholder Value: The Core Motive

At its heart, buybacks aim to enhance shareholder value, which is often synonymous with a rising share price.

When a company buys back shares, it reduces the total number of shares outstanding. This, in theory, increases the value of the remaining shares held by existing investors.

It functions on the principle of basic supply and demand. Less supply (fewer shares) with the same or even higher demand (investors still wanting to own the company) can lead to a higher price per share.

Maximising Shareholder Returns: A Corporate Goal

Indian companies, similar to their global counterparts, often strive to maximise shareholder value.

This essentially means generating the highest possible returns for their investors. Buybacks, alongside dividends, serve as tools to achieve this goal.

While dividends directly distribute cash to shareholders, buybacks offer some distinct advantages:

• Direct Boost to Share Price: The primary objective of a buyback program is often to propel the share price upwards. The company's board might believe the stock is undervalued, making it an opportune time for a buy back. This action can also be interpreted by investors as a sign of management confidence. After all, a company wouldn't repurchase shares they anticipate a decline in price.
• Tax Efficiency: Dividends are taxed as income in India, whereas rising share prices themselves aren't taxed. While those selling their shares back to the company might incur capital gains tax, existing shareholders who hold onto their shares benefit from the increased value without additional tax burdens.
• Greater Flexibility Compared to Dividends: Companies initiating new dividends or increasing existing ones essentially commit to long-term payouts. Reducing or eliminating dividends later can lead to disgruntled investors and a potential drop in share price. Buybacks, however, are one-time events, offering management greater flexibility.
• Offsetting Dilution: Growing companies often offer stock options to attract and retain talent. When employees exercise these options, it increases the total number of shares outstanding, potentially diluting the ownership stake of existing shareholders. Buybacks can help counteract this dilution effect.

How to Evaluate a Buyback Plan?

So, the main question is how can investors evaluate a buyback plan. Here are some important factors to consider:

• To evaluate a buyback plan, investors should thoroughly examine the buyback details. This entails scrutinizing the company's announcements and filings to understand the size, timeline, and method (e.g., tender offer or open market purchase) of the buyback.
• Additionally, investors should assess the purpose behind the offer. They need to evaluate the stated purpose of the buyback and its alignment with shareholder value creation. For example, if a company is using surplus cash in buybacks, it may also signal a lack of avenues for growth in reusing the capital in the company.
• Another critical aspect is reviewing the buyback price. Investors should compare the buyback offer price with the prevailing market price. If the buyback price is not significantly higher than the market price, it may not provide substantial value to investors.
• Furthermore, investors should consider the financial health and growth prospects of the company. This involves evaluating the company's profitability, cash reserves, debt levels, growth prospects, dividend policy, and potential for capital appreciation. They need to determine whether participating in the buyback aligns with their investment objectives and risk tolerance compared to other investment opportunities.
• Lastly, investors should examine the company's buyback history. By analyzing past buybacks, they can understand how the company has utilized them. Have previous buybacks resulted in long-term value creation for shareholders, or were they primarily aimed at short-term stock price boosts?

Indian Buyback Leaders

48 companies spent Rs 480.8 bn on buying back their stocks in 2023.

Most firms that have gone for buybacks are typically from the cash-generating and low capex sectors such as IT, FMCG, and pharma.

Here's a look at companies that spent the highest amount on buying back their shares.

Top Buyback Leaders of the Decade

Company	Number Of Buyback in Past Decade	Amount Spent as Of January 2024 (Rs in Billion)
Tata Consultancy Services	5	830
Wipro	5	455
Infosys	4	397.6
Larsen & Toubro	1	100
NMDC	3	99.1

Source: Equitymaster

Tata Consultancy Services (TCS) leads the buyback game with a robust history of stock repurchases.

Over the past decade, TCS has conducted five buybacks: in 2017, 2018, 2020, 2022, and 2023. The first three buybacks were each Rs 160 bn, followed by Rs 180 bn in 2022 and Rs 170 bn in 2023, totalling Rs 830 bn.

Wipro follows, having consistently conducted buybacks since 2016. The buyback amounts were Rs 25 bn in 2016, Rs 110 bn in 2017, Rs 105 bn in 2019, and Rs 95 bn in 2020, bringing the total to Rs 455 bn.

Infosys has carried out four buybacks in the past decade. The first buyback in December 2017 was worth Rs 130 bn through the tender offer route. This was followed by a Rs 82.6 bn buyback in 2019 through the open market route. Another buyback occurred in October 2021, also via the open market, and the latest was in 2023 for Rs 93 bn, totalling Rs 397.6 bn.

Larsen & Toubro (L&T) has conducted one buyback in 2023, amounting to Rs 100 bn. NMDC has executed three buybacks, with Rs 99.1 bn spent over the past decade.

Are Buybacks Good For Investors?

Whether stock buybacks are good for investors depends largely on the context in which they occur.

A company that repurchases its stock while neglecting other important priorities is likely to make a mistake that will cost shareholders in the long run.

However, if a competent CEO initiates a buyback after effectively investing in the company's operations, it can be a wise move. This approach indicates that management is focused on using shareholders' money for attractive investments, which bodes well for the future of the investment.

To determine whether a specific buyback is a good use of investors' money, several key questions should be addressed:

Why is the company conducting the repurchase? Is it simply to absorb shares issued to management, or is it genuinely intended to enhance shareholder value? Are the shares being repurchased at attractive prices, and does the management team have a strong track record of delivering returns?

Thus, evaluating the rationale and context of a buyback is essential in determining its potential benefits for investors.

Upcoming Buybacks

The following is a list of upcoming buyback of shares in 2024 by listed companies at NSE &BSE

Company	Buyback Type	Buyback Size (Rs in Billion)	Buyback Price per share	Record Date
Anand Rathi Wealth	Tender Offer	1.6	4,450	3-Jun-24
Cheviot Company	Tender Offer	0.3	1,800	14-Jun-24
eClerx Services	Tender Offer	3.9	2,800	NA
Bajaj Consumer care	Tender Offer	1.7	290	NA
Sharda Motor Industries	Tender Offer	1.9	1,800	NA

Source: Equitymaster

Apart from this, here are some shortlisted companies with high cash balances and low debt on their books that may announce a buyback in 2024.

• HCL Technologies: At the end of financial year 2024, the company had a cash balance of Rs 76.3 bn and is debt-free. With a rich history of 5 buybacks in past decades and considering the cash lying on the books, and IT companies' love for share buybacks, HCL Tech could announce a buyback in 2024.
• Coal India: Coal India has conducted buybacks in 2017 and 2019. With a substantial cash balance of Rs 302.4 billion at the end of FY24, the company may soon announce another buyback.
• Engineers India: At the end of FY23, Engineers India had a cash balance of Rs 10.2 billion and is also debt-free. With one previous buyback, the company shows potential for another buyback announcement in 2024.

Conclusion

Share buybacks, though a common practice, are subject to debate regarding their efficacy and impact.

One significant concern is the possibility of misallocation of capital. If a company engages in buybacks at inflated prices or when better investment opportunities exist, it can erode long-term shareholder value.

Additionally, buybacks might be used to artificially inflate earnings per share (EPS) without addressing underlying operational issues or strategic shortcomings.

This short-term focus may undermine the company's ability to innovate and adapt to changing market dynamics, ultimately compromising its competitive position.

While share buybacks can serve as a tool for companies to deploy excess capital and enhance shareholder value, they are not without risks.

Investors should exercise caution and conduct thorough due diligence, evaluating the management's competence and strategic rationale behind buyback decisions.

Ultimately, investing in companies with prudent and transparent capital allocation practices is key to maximising long-term returns and mitigating potential downsides associated with share repurchases.

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