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Buyback of shares: Fool’s Gold

The first six months of 2018 witnessed the announcements of buyback of shares amounting to ₹ 213 billion. Companies which become cash rich and are sitting with huge reserves reward the shareholders with buyback scheme. This in simple terms is returning the excess cash to the shareholders. But again buybacks are also announced to hold to fall in the stock prices (recent PC Jewellers case).

If we have a close look at this engineered product we find that is a stratagem to enrich the promoters and top executives and at the same time make the company look good. This article explains the theme in simple manner.

Suppose X Ltd. Has following shareholding pattern.

Now the company comes up with a scheme to buyback 1000 shares. After successful buyback the shareholding pattern looks like this :

Let’s see it graphically:

Can you see what has happened? The promoters and directors % shareholding has increased from 50% to 55.56% without putting a single rupee from their own pocket! They are getting rich with Company’s money!

Now how buyback makes the company look good. Every player in the stock market looks at EPS (Earnings per share). What is EPS? It is company’s earnings figure divided by the number of outstanding shares.

Suppose Company X Ltd. in above example has earnings of say ₹ 90000. Then EPS of the company is 90000 / 10000 = ₹ 9/share.

Now let’s see what happens to this after buyback. The same earnings of ₹ 90000 result into EPS of 90000 / 9000 = ₹ 10/share. The reason in hike in EPS from 9 to 10 is not the increase in earnings but reduced number of outstanding shares!

Remember that buyback is just getting part of your own money back. It is not dividend or bonus which are share of profits. Only 28 companies announced the buyback worth ₹ 213 billion. It’s easy to see that manipulation of the EPS of 28 companies can produce bullish sentiment in the market. The rise in EPS needs to be checked for if it is caused by buyback or there is real increase in the total profits. In fact total profits may decline while EPS may rise! Clever Deception!

Again buybacks send a message to the market that the share is trading at a price less than it’s intrinsic value. It shows an increase in advertised EPS than in the real EPS which will certainly preferred by promoters as does involve any hard-work. Not only EPS but other ratios like return on assets and return on equity start looking better!

Are buybacks designed to deceive? Buybacks help in defeating the acquisitions also. One needs to analyze the reason for buyback. Why promoters would be wanting to increase their % shareholding could provide some valuable inputs.

Do the buybacks really help the stock price? It is easy to assume that but the market is smarter. Buyback stocks as a whole tend to under perform. Buybacks hurt the shareholders. The money spent on buybacks can be better utilized in research and developments, innovations and good acquisitions. Not to forget the basics, to increase in the net worth of the shareholders.

Buyback of shares: Fool’s Gold
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