Buybacks let companies return excess cash to shareholders, often more tax-efficiently than dividends.
Reducing share count boosts metrics like EPS and signals management’s confidence in future growth.
Investors can either exit at a premium through the buyback or stay invested for improved ownership value.
Information technology giant, Infosys just announced it’s biggest-ever buyback plan to repurchase shares worth a staggering Rs 18,000 crore from its shareholders. The announcement left investors beaming with joy as the company aimed to give a return gift to shareholders in the form of the excess cash surplus, while also shoring up confidence in the company’s fundamentals and long-term growth trajectory.
The buyback also does another job. Announced at a 19% premium to the last closing price, the share buyback also gives investors a chance to offload their holdings at a decent margin, especially since Infosys shares sit in a bear territory, down 23% from its peak.
But are those the only reasons that companies choose to take the buyback route? Not really. When a listed company announces a share buyback, there lies a set of decisions that directly affect investors’ wealth, a firm’s capital structure, and the signals management sends to the market.
In simple terms, a buyback is when a company repurchases its own shares from existing shareholders, reducing the total number of shares available in the market. But the reasons for doing so and what they mean for shareholders are far more layered.
Returning Cash, Without Saying the Word “Dividend”
For cash-rich companies, particularly those in mature sectors such as information technology, a buyback is often about rewarding shareholders. Infosys and TCS, for instance, have repeatedly announced buybacks worth thousands of crores. These firms generate steady profits and pile up cash reserves far beyond what is immediately required for expansion. Instead of parking that money in low-yield deposits, management chooses to return it to shareholders.
That said, a question that often emerges is why go the buyback route when a company can just increase its dividends? Well, India’s tax structure provides that answer.
In India, dividend payouts are taxed in the hands of investors, while in buybacks, the tax is paid by the company. For many shareholders, that structure is more efficient. A buyback, therefore, functions like a dividend in disguise but one that may take off the burden of paying taxes for investors.
Boosting Earnings per Share
Another motivation is improving financial metrics. When a company reduces the number of shares in circulation, the same level of profits gets distributed across fewer shares. This lifts the earnings per share (EPS) number, which is closely tracked by investors and analysts. A higher EPS can make the stock look more attractive relative to its peers, potentially improving the price-to-earnings ratio.
For shareholders who do not tender their shares, this can translate into a higher proportionate ownership of the company.
Sending a Message and Undervaluation
Buybacks are also an easy way for the management’s to send out a signal to investors, a tool they use often in times of distress. When a board approves a buyback at a price above the current market level, it tells investors that the management believes in a higher potential for the stock when compared to its current valuations. This move also acts as an attempt to prop up investor confidence, signal management’s backing for stronger growth prospects and lift falling stock prices.
Take Infosys’ case for example. The timing of the share buyback plan is telling. The stock is firmly sitting in a bear territory with concerns over slowdown in deal wins, faltering demand outlook and global trade uncertainties clouding its future prospects.
Announcing a mega share buyback at such a time sends a clear signal to analysts and investors that the management remains confident of seeing better times in the future, reassurancing stakeholders that the company’s fundamentals remain sound, even if the market has temporarily lost faith.
Defending Against Hostile Takeovers and Dilution
Even though it’s less a frequent motivator, but buybacks can also be used as a defensive tool. By shrinking the pool of freely available shares, the management can make it harder for hostile bidders to accumulate control.
Mindtree, for example, considered a buyback in 2019 when faced with a takeover attempt by Larsen & Toubro.
Another driver is dilution. Many companies issue stock options to employees as part of their compensation packages. To prevent existing shareholders’ stakes from being watered down, firms may repurchase shares to balance the equation.
What it Means for Investors
For shareholders, the implications depend on whether they choose to participate. Those who tender their shares in a buyback receive an exit at a guaranteed premium price, often higher than what the market is offering. Those who stay invested benefit from improved ratios like EPS and return on equity, and potentially from a stronger share price once the buyback signals confidence.
