Buybacks are back on D-Street: Analysts advise focusing on these two factors before chasing them

Shares of Larsen & Toubro (L&T), the construction and infrastructure major, scaled a record high of Rs 2,673.60 apiece on the BSE on Wednesday (July 26), a day after the company announced a Rs 10,000 crore share buyback along with the release of its June quarter (Q1FY24) numbers. Investors cheered the buyback plan, which is the first by the infra giant, thus propelling the stock to a new high. Its robust Q1 numbers, too, aided the stock price.

And L&T is not alone. Of late, a spate of domestic companies have announced share buybacks, thereby lifting their share prices to impressive highs. For instance, Aarti Drugs hit a fresh 52-week high earlier this week after the company announced that its board had approved plans for a buyback of 6.65 lakhs fully paid-up equity shares, representing a 0.72 per cent equity.

Before that, BSE Ltd announced it would buy back 45.9 lakh equity shares, representing 3.39 per cent of the total number of equity shares in the total paid-up equity capital of the company as of March 31, 2023. The stock exchange said it would spend Rs 374 crore on the buyback.

Besides, names such as Amrutanjan Health Care, IndiaMart InterMesh, Ashiana Housing, and Goldiam International have also announced share buybacks and more companies may do so in the coming days.

So, as an equity investor, what should you know? 

First things first, a share buyback is nothing but the repurchase of a certain amount of a company's outstanding shares, either through a tender offer or via an open market route. In a buyback, the price of the concerned shares is generally higher than the prevailing market price.

Any company goes for a buyback of shares if the board feels that the stock is undervalued or, in some cases, if the company does not have any productive use of the free cash on its books and would prefer to return it and reward the shareholders through a buyback of shares rather than dividend payouts. However, one must exercise caution before chasing buybacks, according to analysts.

Moreover, an investor should focus on two things: the premium, which means the price at which the companies are planning to purchase back outstanding shares, and the percentage of the total paid-up equity capital that is intended to be bought back.

Generally, the buyback of shares is seen as positive by investors and indicates the confidence of promoters in the business. Consequently, the share price normally reacts positively to buyback announcements. But the share price movement also depends on many other factors, like the quantum of the buyback, the premium offered to prevailing market prices, and whether the promoters will also tender their shares, says Gaurav Dua, Head, Capital Market Strategy, Sharekhan by BNP Paribas.

"These aside, but importantly, investors should consider fundamental factors like growth outlook and valuations. So, as an investor, you need to take various factors into account and not simply chase any stock based on the news of a buyback," Dua adds.

G Chokkalingam, Founder and Managing Director, of Equinomics Research, says that a lot of investors get carried away by the premium price. For example, if a company's current market price is Rs 500 and it plans to buy back the shares at Rs 700, there's a Rs 200 premium, and people rush to purchase the stocks in order to get eligible for a buyback offer, leading to a sharp spike in stock prices.

The market expert explains that premiums are important, but what is even more important is the quantum of equity that is planned to be bought back. Investors should focus on the percentage of equity the companies are planning to buy back.

Echoing similar views, another market expert, who did not want to be quoted, gave an example:

BSE Ltd, in 2019, did a share buyback of over 13 per cent of the equity. Now, that's a solid move for the shareholders because the benefit to them will be significant. On the other hand, if a company plans to announce only 1 per cent of the equity to be bought back, even if the premium is 50 per cent, the gains for the shareholders would be insignificant. Also, when the buyback percentage is high, it will be EPS-accretive because shares bought back will be cancelled; hence, the earnings per share (EPS) will jump.