Share buybacks: How can retail investors benefit from it?
Most buybacks are done at a premium to the market price and that becomes profitable to shareholders.
All financial newspapers and portals have highlighted the Rs 9,200 crore buyback offer by Infosys. This may be the first buyback of FY 2021-22 but in FY21, India Inc bought back shares worth around Rs 40,000 crore. So, why are companies taking this route? Also, how can a retail investor benefit from it? Let us first see what buyback means.
What is buyback?
Companies sitting on large cash reserves which do not have alternate investment opportunities opt to return the excess money to shareholders. Such an exercise in which a company repurchases its own shares is known as buyback. It is one more way of rewarding the shareholder apart from the dividend. Most buybacks are done at a premium to the market price and that becomes profitable to shareholders. Hence, a buyback benefits a shareholder in two ways. First, when a company commits to buyback the stock at a certain price, it is interpreted as an indication that the company has the confidence to buy the stock at that price. That acts as a psychological base price for the stock. Second, the buyback leads to extinguishing bought back shares, thereby reducing the number of outstanding shares which in turn increases the earnings per share (EPS) of the company making it value accretive for shareholders.
How does buyback benefit you?
From a shareholder’s point of view, buybacks are better than a bonus or a dividend issue as they get to choose between different options to maximise their benefits. Investors who do not wish to stay invested in the stock can use the buyback offer to exit as usually, it is at a significant premium to the market price.
On the other hand, if you are bullish on the prospects of the company and do not wish to participate in the buyback you will still benefit. As the buyback will reduce the number of outstanding shares thereby making it value accretive as earnings per share will improve.
Methods of buyback
There are multiple ways in which a company can do buyback namely direct buyback, open market, fixed price tender offer and Dutch auction tender offer. In India companies going for buyback usually opt for open market or fixed price tender offer. So, let’s understand what these are:
Open market: In this case, the company buys from the open market up to a maximum price fixed by it. It means once the buyback starts the company repurchases the shares at the prevailing market price which might be lower than the buyback price. As the company initiates share purchase it can lead to price rise due to a jump in demand for the shares. However, the company will buyback only till the price notified in the buyback. Generally, these offers are for longer periods so as maintain price volatility. Promoters are not allowed to participate in this buyback.
Fixed tender offer: All shareholders including promoters can take part in this type of buyback scheme. Shareholders have the option of tendering the shares back to the company during the buyback period at the price fixed by the company. In this method, the company will repurchase the shares at the fixed buyback, unlike the open market where it can buy below the buyback price from the market.
Take the case of Infosys. The stock is quoting between Rs.1,350-1,360 but the buyback price has been set at Rs.1,750 through the open market route. Once the buyback is approved by the shareholders the company will announce buyback open and close dates. Since it’s an open offer route the company will repurchase the shares at market rates prevailing at that time up to Rs 1,750.
From a shareholder point of view, the buyback price of Rs 1,750 acts as a psychological base price for the stock. Unless you really need money or are bearish on the future prospects of the company, it is better to stay invested and not get tempted by the buyback offer. Once the shares are extinguished earnings per share will go up and in turn benefit you.