Are share buybacks a win-win situation?

CEO-and-Co-founder-Cians-Analytics-Aman-ChowdhuryIndian companies have been witnessing a large cash build-up — average cash reserves with the BSE Sensex constituents increased from ~INR 325.7 Cr to ~INR 6,000 Cr, a staggering CAGR of 38.2% during 2005–2013. 

With huge piles of cash, India Inc. now faces a double dilemma — on the one hand, the global recession is a thing of the past and, on the other, domestic economic growth and activity are expected to remain benign over the medium term. 

A large cash build-up, without adequate avenues to invest the excess cash, leaves companies with two primary options to return money to shareholders: a cash dividend or a stock buyback. 

Given the long-term signaling impact of a cash dividend whereby shareholders start expecting future dividends on the basis of the current dividend, a stock buyback may be the preferred method of rewarding shareholders.  We at Cians analyzed the empirical data for the 50 recent buybacks in India (amounting to INR 25,000 Cr) and their relative performance over a six-month period after the buyback was announced. 

Observations: 

On an average, buyback of shares was offered at a premium of ~25% 

Mean adjusted return (mean return of the stocks over and above the SENSEX return) for the data was ~10%, while the median return was roughly -3% 

This huge difference between the mean and the median was due to the fact that while some stocks produced returns of more than 100%, others underperformed SENSEX and lost value over time 

A closer look at some of the recent largest outperformers and underperformers reveals: DCM Shriram’s and Infinite Computer Solutions’ buybacks stand out as successful programs, while that of JBF Industries and Sinclairs Hotels weren’t very successful. 

The single most critical factor that separated the successful vs. not so successful program was “timing”. While managers at DCM Shriram and Infinite Computer Solutions managed to invest in their own stocks when the stocks (on a P/E multiple basis) seemed undervalued, their counterparts at JBF and Sinclairs Hotels misread the markets and initiated buybacks at a time when valuations were sky high, i.e., overvalued. 

In conclusion, a buyback decision may always seem like an attractive option when management has excess cash on hand. But the reality is not all buybacks are destined to be successful. Success or failure of any buyback depends largely on getting the choice of your investment “timing” right. Well, it’s not an easy choice to make. 

With huge piles of cash, India Inc. now faces a double dilemma — on the one hand, the global recession is a thing of the past and, on the other, domestic economic growth and activity is expected to remain benign over the medium term, meaning neither do you need a war chest to stay afloat nor that growth opportunities are abundant. 

The million dollar question is what do you do with such deep pockets then? A large cash build-up, without adequate avenues to invest the excess cash, leaves companies with two primary options to return money to shareholders: a cash dividend or a stock buyback. Given the long-term signaling impact of a cash dividend whereby shareholders start expecting future dividends on the basis of the current dividend, it would seem that a stock buyback may be the preferred method of rewarding shareholders. 

Authored by:- Mr. Aman Chowdhury, CEO and Co-Founder, Cians Analytics

© Technuter.com News Service

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