Share buyback done by a company at a premium to the prevailing market price is generally considered a positive event. Although there’s a merit in this notion, take such claims with a pinch of salt, especially under changing regulatory and business environment.
As you know, the government got rid of the Dividend Distribution Tax (DDT) in the Budget 2020 and made dividend income taxable in the hands of investors. Until then, companies declaring dividends paid DDT at an effective rate of 20.56%.
Now that the dividends are charged at slab rates applicable to individuals (subject to TDS if the amount exceeds Rs 5,000), ‘dividend’ has become relatively unattractive option for big shareholders falling in the maximum tax bracket, including the promoters.
As against that, the effective tax rate applicable to a company doing the buyback is 23.3%. Buyback proceeds are tax free in the hands of investors. As a result, Indian companies have been resorting to buybacks as a tool to distribute surplus cash.
(Source: Business Standard, BSE India, Ventura Research)
No wonder then, India Inc set aside more money for buybacks in FY21 than in FY20; despite it being a difficult year for businesses due to the pandemic.
Investors often demonstrate a tendency to buy shares that trade at a discount to their buyback price. True, buybacks allow price discovery to some extent but following this strategy in isolation may prove risky at times.
Careful analysis of companies that made a buyback offer to their shareholders reveals that they are either mature businesses that generate huge free cash flows, or, mature low growth businesses that don’t have specific plans to utilize cash. Besides, companies earning low return on equity also prefer the buyback route to look better. It’s noteworthy that as the capital base shrinks, Earnings Per Share (EPS) increase automatically even without any change in the net profit.
You may also want to evaluate the impact of the changing investment climate. For example, ESG (Environmental Social and Governance) compliance score plays a crucial role in deciding the valuation multiples markets are willing to pay.
As not everything that shines is gold; not all companies that make a buyback offer at a huge premium over the prevailing market price are attractive. Watch out for growth companies making buyback offers at a premium wherein promoters aren’t utilizing the threshold they are entitled to.
If the promoter is also participating in the buyback, the buyback may not even be an attempt to raise stake in the company. Now that dividends have become unattractive for big boys on the street, buybacks might become prevalent. The government has also earned Rs 3,936 crore by participating in CPSE buybacks in FY21.
Do you know how much dividend you earned in FY21?
Since dividend is a taxable income now in the hands of investors, keeping track of dividend income is crucial.
If you have a demat account with Ventura securities, you don’t have to go through the hassle of maintaining dividend records manually. You can simply download the dividend report from Ventura’s website and reconcile the entries with passbook records.
In case you aren’t sure how to use the report or where to download it from, watch this video
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Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.
If you are investing in any family run company, besides governance, you may also want to take stock of significant developments in the lives of the promoters. Sometimes, their personal life can overshadow market sentiments. Also pay attention to issues such as pledging of shares by the promoter group and the working capital.
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