Buyback is trending, want to know why?

In last year's budget, the Union Finance Minister declared a special tax of 10 per cent on dividends above Rs 10 lakhs, in addition to a distribution tax of 20 per cent. Many companies went on to declare dividends after the announcement. And those who missed the opportunity are now taking the route of buyback.

In a buyback, the company purchases its own shares from the open market. Subsequently, it cancels them or keeps them as treasury shares. The whole buyback process reduces the company's outstanding shares. If a company is going for a buyback, it means that the company has adequate cash to buy its own shares and is willing to reward its shareholders. It could also mean an improvement in financial ratios such as earnings per share, return on assets, and return on equity.

Buybacks is gaining importance more than dividends these days, as they have become more tax efficient in India. In 2016-17, buybacks were at six-year high with 41 companies announcing a buyback against just 16 last year. India's IT giants TCS & Infosys are sitting with huge cash and cash equivalent of USD 5.69 billion and USD 5.25 billion respectively, which accounts for ~40 per cent of their total balance sheet size. And, given the good correction in the valuations over the last one year, a buyback can be one option over dividends. Moreover, TCS on February 20, 2017 had announced a buyback.

Those who are long-term investors, this buyback will lead to capital appreciation. The lower number of outstanding share will definitely increase the EPS and return on equity. And, from long term perspective, these two ratio matters a lot.