Stock buyback announcements have picked up the pace in the last two to three months. According to data from Prime, there are as many as 11 listed companies, including ICRA, Lakshmi Machine Works, McLeod Russel, Music Broadcast, Natco Pharma, NALCO and NLC, who are at present offering investors a chance to participate in their respective buyback offers.
Though share buybacks in the classical sense amount to distribution of cash to shareholders (similar to dividends), their key differentiating factor is the ensuing signalling effect for investors. The company feels the stock is cheap and if investors want to exit, the company will buy the stock from investors.
When stock prices fall steeply or stay flat for a long time, company promoters often announce a stock buyback, virtually giving their take on the future prospects for the stock. This is a dilemma for the average retail investor. Like Shakespeare's Hamlet, share buybacks are the 'to be, or not to be' event. DNA Money spoke to experts to understand how you should evaluate such an offer.
Buyback relevance
Buyback of shares can be done either through the open market or tender offer route. Under the open market mechanism the company can buy back its shares from the secondary market. During buyback of shares via tender offers, shareholders can submit or tender portions of their shares within a stipulated time.
Retail investors can use some basic guideposts to assess stock buybacks. Vikas Jain, senior research analyst, Reliance Securities says that it depends upon which company is announcing buybacks. "Some of the criteria investors should consider while surrendering their shares in a buyback include premium to the existing price during the buyback period, acceptance ratio with respect to shareholding pattern, are promoters tendering in the buyback, and post buyback will the investor be able to sell the balance shares at a decent price," he advises.
Some fund managers view buybacks as an opportunity to tender large quantities of shares at an agreeable price, without impact cost. The decision to sell is based on an understanding of the fundamental prospects of the business and its current valuation.
"If promoters are increasing their holding in a company by buying shares from outgoing shareholders, it is good. We must be able to find out if the buyback is due to lack of need of 'growth capital'. If there is lack of growth opportunities, capital is available for buyback," says an equity fund manager with an AMC. Probably for this reason, the industrials, IT, material and healthcare sectors show a higher incidence of buybacks.
If the company has a strong management and the investor is able to make more than 15% on the buyback price, then she/he should consider the buyback. Depending upon the acceptance ratio, she/he will receive the shares after a certain time frame to sell in the market or keep for long term. If the price is near to the buyback price in a range of 3-4%, it's better to sell in the market and invest the proceeds in some other shares, says Jain.
There would be cases where investors should avoid a buyback. "If the amount of shares being kept is only for 10-15% of the acceptance, then one should avoid. At least 40-50 % of the shares should be accepted in buyback to make it worthy for the investor," added Jain.
For managements that are optimistic about the growth prospects of the company, a buyback offer done at a time when the market price is depressed provides an opportunity to buy back shares at a discount to fair value. This enhances the value for the continuing shareholders.
On the flip side, for businesses with excess cash, but the unavailability of value-enhancing investment opportunities, or the stock being overvalued, the announcement of a share buyback followed up by the participation of company insiders could be a neutral to negative signal.
Good fundamentals, say no to buyback
Many companies are known to use the stock buyback ploy to lift the sagging fortunes of their stock. According to a study, median returns of the stocks over a 12 month period from the day of announcement of buyback stood at 29%. Only 22% of the stocks gave negative returns over the same period.
There are a quite a few global gurus who even prefer buybacks to dividends. For example, Warren Buffet is known to be averse to paying dividends due to better prospects of deploying capital. Yet, he is open to share buybacks if Berkshire Hathway stock price were to dip below 1.2 times of its book value. In the Indian context, things are different. Companies do not explicitly say when they feel a stock is under-valued.
"If investors have a long term perspective and the growth prospects of the business are good than long term investors should not participate in the buyback program. Many a times companies also do buyback if they believe that the stock is undervalued and it is a strong signaling mechanism for the long term prospects of the business," says Pankaj Murarka, founder, Renaissance Investment Managers.
Buybacks come at a price. If the market price comes near the buyback price, you can sell the shares to the company or in the market itself. But the exit price is where the confusion arises. A simple way to decide is to ask yourself about the company's fundamentals and outlook.
Sanjeev Hota, AVP research at Sharekhan, by BNP Paribas feels that core business fundamentals and long-term growth prospects play the most important role to drive long-term stock performance and create wealth for the investors. That said, buyback offers may drive short-term investors' sentiments as it shows management confidence in the company and also could be a lead indicator for prudent company's capital allocation policy to reward investors he points out.
Should investors be guided alone by the buyback price or look deeper into fundamentals? Hota says that if the buyback price is attractive with favourable acceptance ratio, then investors may consider it for short-term tactical investment opportunity and tender shares in the buyback to get short-term gains. "However, for long-term investments, investors should take a holistic view on company growth prospects and core fundamentals and should not alone be carried away with any lucrative buyback offers," Hota argues.
TO SELL OR NOT TO SELL
- Check premium to existing price, acceptance ratio with respect to shareholding pattern, are promoters tendering in the buyback and whether you can sell balance shares post buyback
- If investor is able to make more than 15% on buyback price then consider the buyback. If price is near to buyback price in range of 3-4% it is better to sell in market
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