What You Should Do During A Share Buyback

UDAYAN RAY Welcome to Fundoo Money, your 24X7 buddy on all matters related to personal finance. In this particular web series, we are discussing various things people need to keep in mind while investing in stocks. That’s right, stocks. And these are not tips to make you get rich quickly. This particular series is aimed at making you into a smart investor.

Now lot of people hear a lot of things about a term called buyback and they keep wondering what it is all about. Now, in this particular segment we’ll be discussing what a common investor needs to keep in mind when a buyback announcement is made. That follows shortly.

Well as I was saying buyback is an oft used term that keeps coming on and off in various stock market news, discussions etc. Now what is it all about and what does an investor need to keep in mind? To help us figure this thing out we have stock market expert Mohit Satyanand.

Hi Mohit!

MOHIT SATYANAND Hi Udayan!

UDAYAN RAY Mohit the word buyback—isn’t it all about buying something back? So, I presume when people are talking about buyback of shares it’s the company buying back its shares which it had given out in the first place. But is it just that or there is something more to it? And are there other opportunities out there for investors?

MOHIT SATYANAND Yeah, so we’ve largely seen two kinds of buybacks. The idea of a buyback typically speaking has been that a company now is not growing so rapidly. And, or, that it’s generating a huge amount of cash and therefore it feels that the best use that it can make of all this money that is lying in its coffers is not to expand its activities but to reduce the floating stock out there so that the return and the earnings per share (EPS) goes up. Okay? And so the investor has an option of saying “you know what at this price I think the share is fairly well priced, and since the company is not going to be growing so rapidly, I might as well exit”. 
But there is another kind of buyback, and this one is a very strange kind of buyback. And we’ve seen this animal in the Indian markets recently. Which seems to be a company is not doing well, and in fact it has fairly substantial borrowings. The share price is falling. And then the management announces a buyback. And it seems to be the fond hope that by this buyback, the share price will stop dropping, or will start rising. This doesn’t work.

It’s not going to work because if the company had so much money, they could keep buying its stock in order to raise the price, you wouldn’t have the borrowings out there in the first place, and the stock wouldn’t be dropping in the second place. And secondly, it’s a bit of an illusion because the amount of money that they dedicate to that buyback is so small that it can’t materially affect the impact of the price.

So I think you have to be careful about what the idea of a buyback is. But finally, it comes to the same thing. Do you think that a share is well priced at a particular price or not. If you think it isn’t, the buyback theoretically gives you an opportunity to get out.

UDAYAN RAY So one thing comes out very clearly. There is no set formula for figuring out what buybacks are. At the end it comes back to good old earnings.

MOHIT SATYANAND Absolutely, absolutely.

UDAYAN RAY And how well a company is performing, how well a company is utilising the capital it has raised. So these are the two critical things. It’s almost like the way your health is. How well are your vital indicators? What is the story they are telling? Other things are actually linked with that.