In a share buyback, make a tactical bet if price gap is attractive

In a buyback, purchase the stock early from the market or else the price gap could close

Share buybacks have become the flavour of the season, with companies such as TCS, Wipro, and Majesco announcing them. A key question to answer is whether retail investors, who generally have long-term financial goals, should participate. 

Experts seem to be divided. Some think you may. Feroze Azeez, deputy chief executive officer, Anand Rathi Private Wealth, says: “While a retail investor should largely follow a personal finance plan that is strategic in nature, he can sometimes undertake a few tactical transactions that propel him towards his objective. Buyback is one of them.” 

In a buyback, a company buys its shares at a price that is higher than the prevailing market price. The premium encourages shareholders to opt for the buyback. The arbitrage opportunity also encourages many investors who don’t own these shares to purchase them from the market and tender them. 

One variable that plays a crucial role is the acceptance ratio —the number of shares finally accepted as a percentage of the total tendered back to the company. The higher the ratio, the better. Ambareesh Baliga, independent market expert, says: “Generally, for retail investors, the acceptance ratio is better than for high net worth individuals or institutions. So, retail investors should utilise such opportunities, especially when the price gap is decent.”

Investors who wish to make tactical bets on buybacks need to pre-empt others. “If there is a buyback offer, start buying stocks in that sector. There is a herd mentality within sectors. If you start accumulating shares in advance, you will make larger transactional gains,”  says Azeez. The risk, of course, is that the company whose shares you buy may not announce a buyback.

Tactical bets will result in short-term gains. “Set off the gains made against the losses you may have accumulated over the years,” Azeez adds. 

When a company buys back its shares, it pays tax at the rate of 20 per cent on income distributed to shareholders. Gopal Bohra, partner, NA Shah Associates, says: “Income arising to shareholders on buyback of shares on which the company has paid additional tax under Section 115QA is exempt in the hands of shareholders under Section 10(34A) of the I-T Act.” 

Long-term investors should consider the outlook for the sector and the company. Tarun Birani, founder and CEO, TBNG Capital Advisors, says: “Check the sector, management and promoter. Are they doing well?” For instance, he says, IT and Digital continue to do well. In that case, a long-term investor holding stocks of a quality company could be better off just holding on to them. 

For someone who wants to make a short-term bet, he should remember that if the acceptance ratio is low, he may not be able to tender the shares at the given price. Birani adds that there is also a mark-to-market impact that those who take short-term bets need to consider. 

As many investors buy the shares of the company, its stock price rises and moves closer to the buyback price, thereby reducing the arbitrage gain. Regarding quality shares, Baliga says: “If you give your shares in a buyback and don’t buy them from the market again, you may end up a loser.”