100%(2)2 out of 2 people found this document helpful
This preview shows page 1 - 2 out of 5 pages.
9/8/2018Reasons for Buyback of Shares - Share Buyback Benefits for Shareholders | Motilal Oswal1/5NIFTY : 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-AA+6 reasons why a company could consider a share buybackIn the last 2 years we have seen a number of companies,especially companies from the technology sector, announcingbuyback of shares. Before we get into the nuances of buybacksin India let us understand how the global scenario on buybacksoperate. Globally, there are two ways that a company can buyback its own shares. Firstly, it is possible to buy back the sharesand hold these shares as treasury stock in the balance sheet ofthe company. This is used by the company for treasuryoperations. Secondly, you can buy back the shares andextinguish the shares, thus reducing the outstanding shares tothat extent. In India, the first method is not allowed and sharescan only be bought back for extinguishing.So, why does a company buy back shares? What are the reasonsfor buyback of shares? One needs to understand the benefits forthe 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 inThis 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 toshareholders. A company like Reliance Industries may have billions of dollars in cash but it also has massive investments in thefield of telecom. Most of the IT companies are operating on matured business models and there is not much to invest in terms ofnew 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 shareholdersThis advantage became pronounced in India after the Union Budget 2016 when the government announced the 10 % tax in thehands of shareholders if the annual dividend exceeded Rs.1 million. Now, dividends paid by companies are being virtually taxedat 3 levels. Firstly, dividends are a post tax appropriation, and then there is dividend distribution tax (DDT) of 15 % when thecompany pays out the dividend and finally there is the 10 % tax on shareholders. The 10 % tax actually hit promoters and largeshareholders the most. In comparison, buybacks are attractive in tax terms even after considering the 10 % tax on LTCG that wasimposed in the 2018 budget.3. Theoretically buybacks tend to improve valuations of companiesWhen a company buys back shares, it results in a reduction of the number of shares outstanding and the capital base. To thatextent, it improves the EPS and the ROE of the company. When the EPS goes up, assuming the P/E remains constant the price ofthe stock should also go up. However, in practice it does not normally happen. When a company buys back shares it is seen as a