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Share Buyback – the New Normal, Harming True Spirit of Long term Equity Investment

Share Buyback – the New Normal, Harming True Spirit of Long term Equity Investment
Education Series | June 16, 2017

Share Buyback by companies promote short-term speculations in the market, high Dividend Distribution Tax is the culprit.

Whether a company announces a dividend or whether it announces share buyback to the investors, both sound equally good and impressive. But when there’s more than a way of doing something, there`s a chance of one being better than the other. Here, in this blog, we are going to talk about rewarding the shareholders in various ways such as paying off the dividends, doing a buyback and announcing the bonus issue. While bonus is given from the reserves, the other two are related to direct cash payment. However, for the time being, we will limit our discussion to the dividend and buyback only, which are usually paid through hard cash.

Have you ever thought which way is right or more beneficial to the shareholders? Sure you “Haven’t”. A company should do everything that shall serve the interests of the shareholders, even when the shareholding is confined to a single share.

Now think for a while…!! Do you want a dividend or a share buyback as a shareholder?

Being an owner of a company in proportion to the shareholding, the shareholders have every right to receive a share of company’s profit after all the necessary retention. This profit distribution is known as a dividend. A company`s dividend is decided by the board of directors and requires the shareholders` approval too. It is usually distributed in cash and Dividend Distribution Tax (DDT) is paid on the given dividend.

Now, let us go through the share buyback in short. The Buyback is announced by the company to acquire back its own shares from the existing shareholders at fixed price. Some key reasons for doing a buyback includes consolidation of owners shareholding, distributing idle cash to shareholders, supporting share price when the price is undervalued or under distress.

A share buyback is rewarding to investors as it results in higher EPS by reducing a total number of outstanding shares.

After going through the basic meaning and purpose of both the terms, let’s move into the discussion of the quality part of the both.

There are millions of investors who just buy shares of their favorite companies, then forget the holding period and finally keep the dividends as a single pay off and become loyal investors. If I am a long-term shareholder of a company, irrespective of the share price fluctuations over a period of time, what I will look for a dividend payment by the company at a regular interval as parting proportionate profit is at least, the single reward for the investors for being loyal and long-term investors.

Also, dividend plays one of the key criteria while deciding upon the investment for many institutional as well as small individual investors. High dividend yield protects a shield to the share price against any steep price fall in any situation.

How Dividend is healthier

Now, let us go further and establish which is healthier between dividend and buyback and which is a real reward for an investor who has been loyal to his investment?

In the recent years, we are seeing a large number of companies are announcing more and more buybacks than paying off cash in form of dividend to their investors. Be it a company with an average corporate governance or be it one with the highest standard of corporate governance such as TCS, Wipro, HCL Tech etc. who has a rich history of creating a great long-term wealth for investors along with consistent record of paying higher dividends, all are announcing buybacks of small sizes in recent times. But why such a rapid increase in the numbers of buybacks? It could be because of an increase in Dividend Distribution Tax (DDT) from earlier 16% to current 20%. In fact, it has come to our notice that post this increase in tax, more and more companies are announcing buybacks rather than distributing dividends to the shareholders, just to avoid paying DDT to the exchequer.

But unfortunately, it has harmed the basic contention of dividend and skipped the reward to the shareholders who have been loyal and long-term investors.

? TCS has announced a buyback of 5.61 Cr. shares out of which 84.21 lakh shares (15% of the buyback size) are reserved for retail investors. On the other hand, only 49.8% of the reserved category comes out and tenders shares in the buyback. Pre-buyback retail shareholding was 6.33 Cr. shares as per the latest shareholding pattern quarter ended in March 2017.

If we seriously look into this buyback, only 41.97 lakh shares are tendered out of total retail shareholding of 6.33 Cr., which constitutes only 6.53% of the total retail shares held. This simply means that out of total retail shares, only 6.53% could enjoy the benefit of the buyback and for the rest, the event was fruitless. The number was huge who could not be benefitted from the event for various reasons, like for example, because of being unawareness of the buyback, not knowing the process to participate and much more.

This list is long and does not end here. There are end numbers of companies including big names such as Bharti Infratel, WIPRO, HCL Tech, JB Chemicals & Pharma Ltd.

While recently announced buybacks include Cheviot Company and TTK Prestige, other big names like Bayer CropScience and Jagran Prakashan Ltd. have declared buybacks more than two times in last 3-4 years. If these companies could have given a dividend, the reward could have been much more effective for all the investors. Every single share whether retail or otherwise could have been benefitted from the dividend in a secular manner.

If we have to say something about this kind of buyback, then we must say that the aforesaid buyback has reduced and diminished the logic behind rewarding investors to a great extent.

This is why the SEBI was established in order to protect the interests of the investors.

Deserting dividend and choosing buyback as an easy alternative, though unintended may be, is doing a great disservice to the spirit of protecting interests of the investors by encouraging speculative trade activities in the shares of buyback and at the same time discouraging long-term investors by giving nothing to them.

The trend is emerging where Buyback is rewarding active traders at the cost of real long-term investor and promoting speculation instead of investment.

In most of the cases of buybacks, we see that just after the announcement of a buyback, the participants use it as a short term trading tool and start accumulating shares for the purpose of tendering in the buyback and go away with it. This leads to more and more speculative activities in the share price that contradict the real intention of the buyback.

Also, we believe that the Government of India, especially the Ministry of Finance should look into the matter and reduce the rate of DDT to increase the tax revenue and ensure secular reward for investors by way of dividend. Also, corporate should think seriously about the real interests of the investors which in our view lay in the dividend.

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Anurag AroraFundamental research

Anurag is a fundamental research analyst covering Power & Chemicals sector at Narnolia Research. His forte is finding next growth ideas in mid cap stocks universe. He is a member of Institute of Company Secretaries.

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