Reasons for Buyback of Shares - Share Buyback Benefits for Shareholders _ Motilal Oswal.pdf - Reasons for Buyback of Shares Share Buyback Benefits for

Reasons for Buyback of Shares - Share Buyback Benefits for Shareholders _ Motilal Oswal.pdf

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9/8/2018 Reasons for Buyback of Shares - Share Buyback Benefits for Shareholders | Motilal Oswal 1/5 NIFTY : 11,589.10(0.45%) SENSEX : 38,389.82(0.38%) USDINR : 71.8575(-0.41%) GOLD : 30,510.00(-0.12%) Home (/index.aspx) > Article (/share-market-education/new-to-market.aspx)   A- A A+ 6 reasons why a company could consider a share buyback In the last 2 years we have seen a number of companies, especially companies from the technology sector, announcing buyback of shares. Before we get into the nuances of buybacks in India let us understand how the global scenario on buybacks operate. Globally, there are two ways that a company can buy back its own shares. Firstly, it is possible to buy back the shares and hold these shares as treasury stock in the balance sheet of the company. This is used by the company for treasury operations. Secondly, you can buy back the shares and extinguish the shares, thus reducing the outstanding shares to that extent. In India, the first method is not allowed and shares can only be bought back for extinguishing. So, why does a company buy back shares? What are the reasons for buyback of shares? One needs to understand the benefits for the shareholders and for the company in question. The key question is about the share buyback benefits for shareholders. 1. Lots of cash but few projects to invest in This is one of the primary considerations for companies to buy back shares. Typically, Indian IT companies like Infosys, TCS, Wipro and HCL Tech were sitting on billions of dollars in cash. Now, cash in the bank has a cost and it is better returned to shareholders. A company like Reliance Industries may have billions of dollars in cash but it also has massive investments in the field of telecom. Most of the IT companies are operating on matured business models and there is not much to invest in terms of new projects. Too much cash in the books and too few investment opportunities is a key reason for buyback of shares. 2. Buybacks are a more tax-effective means of rewarding shareholders This advantage became pronounced in India after the Union Budget 2016 when the government announced the 10 % tax in the hands of shareholders if the annual dividend exceeded Rs.1 million. Now, dividends paid by companies are being virtually taxed at 3 levels. Firstly, dividends are a post tax appropriation, and then there is dividend distribution tax (DDT) of 15 % when the company pays out the dividend and finally there is the 10 % tax on shareholders. The 10 % tax actually hit promoters and large shareholders the most. In comparison, buybacks are attractive in tax terms even after considering the 10 % tax on LTCG that was imposed in the 2018 budget. 3. Theoretically buybacks tend to improve valuations of companies When a company buys back shares, it results in a reduction of the number of shares outstanding and the capital base. To that extent, it improves the EPS and the ROE of the company. When the EPS goes up, assuming the P/E remains constant the price of the stock should also go up. However, in practice it does not normally happen. When a company buys back shares it is seen as a
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