Are buybacks positive for stock price performance?

By Research Desk
about 5 years ago

A company which is usually flushed with cash (without any need for capex and other investments) goes for a buyback to of shares in order to reward the shareholders for their ownership in the company and also boost stock price.

Generally, buyback takes place at a price higher than the current market price of the stock because the company believes its shares to be undervalued, as also as an incentive to boost shareholder participation in the buy-back.

Buyback reduces the number of shares outstanding in a company thus making the EPS look more attractive, a higher RoE, economic value of the company improves and a lower liquidity levels for the company.

Investors usually cheer such buybacks as they understand that the company doesn’t intend to do something wasteful like making an unwise acquisition or a non-resourceful capital expenditure with the excess cash. For example, the shares of software giant TCS rallied after the news of buyback as the shareholders expected higher EPS and the share looked more attractive to the investors in a long term growth. Also lying with almost zero debt, the company rewarded the investors by paying a greater value for the shares owned by them.

However buy-back is not always viewed positively. It can be viewed as lack of growth options for a company, especially in case of a small and mid-cap company, the investors believe that these high growth companies should reinvest the profits in order to capitalise on the available opportunities.

In this case the stock price of the company will relatively be stable or go down in the long term as the investors don't see a potential growth story based on their estimates. A clear example of such stock was Avanti Feeds which took a buyback in June 2018 after which the share prices kept going down due to the investor sentiment and the company working at less than half of its capacity. This means that the potential growth for the company remains subdued and the estimates for future growth doesn’t holds true, leading to PE contraction.

Thus, a buyback can be viewed as a positive or a negative sign for a company depending on the reason and motive behind the buyback. It is not always an indicator of strengthening a company's financials, which is generally the case only for IT stocks as their need for capital is limited to boost growth unlike a manufacturing firm requiring huge sums of investment for land acquisition, purchase of machinery, working capital etc.

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