What are buybacks and can they dictate near-term stock price movements?

Buy-Back (also known as repurchase) is a corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than th market price

Sandeep Sinha Moneycontrol News

A share buyback (also known as repurchase) is a corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than the market price. When it buys back, the number of shares outstanding in the market reduces.

A buyback essentially allows companies to invest in themselves. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares a company owns.

Buybacks can be carried out in two ways:

Shareholders may be presented with a tender offer whereby they have the option to submit (or tender) a portion or all of their shares within a certain time frame and at a premium to the current market price.This premium compensates investors for tendering their shares rather than holding on to them. Companies buy back shares on the open market over an extended period of time.
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Recently large Indian IT companies such as Tata Consultancy Services (TCS) and HCL Technologies have announced share buyback as they were sitting on a huge cash.

A buyback helps a company to improve earnings per share (EPS), return on assets, return on net worth and enhance long-term shareholder value. It helps to provide an additional exit route to shareholders when shares are undervalued or are thinly traded.

Tax efficiency

Buyback is a reasonably better way of rewarding shareholders than giving out huge dividends. The cost of doling dividend comes at a cost, as the company has to pay more than 20 percent dividend distribution tax. Individual investors have to pay 10 percent tax if their dividend income amount is more than Rs 10 lakh.

Also, companies don’t have to incur additional costs of getting approvals from Courts/National Company Law Tribunal (NCLT) on reduction of capital.

Impact on stock price

A buyback helps support share price during periods of sluggish market conditions and shrug off unwelcome takeover bids. Experts say that buyback is an artificial way of supporting the share price from falling down significantly in the short term.

Many companies in the past have announced share buyback to jack up the share price.

It is important to note that investors need to be aware or stay cautious of the buyback announcements as it could also a signal of marketing topping out and underlying issues such as slowdown in business due to overall macroeconomic factors.

IT majors such as TCS, Infosys, Wipro and HCL Tech have been sitting on a lot of cash even as large brokerages and analysts have a negative or neutral view on many these stocks.It could mean that the business outlook remains muted for these companies.

It must thus be remembered that while buybacks can temporarily impact prices of stocks, business fundamentals drive them over the long term.