How to be a winner, buybacks or not

How to be a winner, buybacks or not

Dividends can wait, share buybacks are the newest tool with companies to charm shareholders. But you can still step aside, and make your point. reveals the code

When it comes to getting shareholders their due, companies so far have shown a clear preference for dividends to achieve the end. Just like this one which sold a stake in its subsidiary for a princely sum working out to over a `100 per share. Investors had expected it to reward the shareholders in some fashion from the windfall. But in the end, the dividend turned out to be a meagre `5. Not all are as tightfisted, though, especially when for the shareholder it’s a question of braving a climate where risks far outweigh the gains. As headwinds continuously blow, a report from Morgan Stanley throws light on a different angle altogether, one of buybacks, to keep shareholders in good humour. The India Strategy report dated August 8 and authored by Ridham Desai, Sheela Rathi, Amruta Pabalkar and Utkarsh Khandelwal talks about how these rewards have grown over the years. “What is new is the growing share of share buybacks in total payout. Apart from being a tool to return cash to shareholders, buybacks are used by controlling stakeholders to raise their stakes and signal the management’s view of the likely return on share prices (i.e., it will be higher than the return on equity, ROE, of the company),” said the quartet. Companies are also using them to the hilt because of the capex lull since they see less reason to employ cash to step up capacity. Sample these numbers. Companies spent `13,765 crore on buybacks in 2012 fiscal, the highest for any financial year since 1998-99. Not content with that, they pumped in another `1,345 crore till July of this fiscal year, according to data from Prime Database. A lot of this is exemplified by Reliance Industries which launched India’s largest ever buyback exercise in February. It has bought back around Rs 2,800 crore worth of shares from the public thus far and plans to spend up to Rs 10,440 crore by January 19, 2013. This sudden surge in buybacks may have something to do with promoters looking to increase their stake in a company. Buybacks typically take place when there is some cash flow, but the company is unsure about where to deploy the capital and this usually coincides with a fall in share price, according to Jitendra Panda, head of sales-broking at Future Capital Securities. “It shows confidence that the business will improve… and also helps promoters shore up their stake indirectly,” he said. The math is simple. When the public tenders its shares, the total proportion of promoter-held shares in the overall shareholding moves up automatically. Interestingly, the Morgan Stanley report also examines the effect of buybacks on those shareholders who choose to stay put. “Median outperformance is statistically insignificant until the passage of 12 months after commencement of the buyback. In any case, buybacks yield excess returns only in a 12-month period -- there is no short-term benefit,” said the report which based its conclusions on an analysis of all the buyback transactions in India (125 companies) since 2005. Their analysis reveals that about half the stocks have outperformed the Sensex over the 12 months after their buybacks started, overall, since 2005. The excess returns are a function of a positive change in fundamentals such as improvement in ROE following the buyback, stated the report. It typically takes a year for investors to recognise the effect of the buyback, agreed Panda. “It is only in the quarter after the buyback is complete that the return on equity begins to improve. It may take another couple of quarters for new investors to buy into the company. So, a 12-month lag is understandable,” he explained. Chokkalingam G, executive director and chief investment officer at FCH Centrum Wealth Managers, feels the effect of a buyback is linked to the time taken to execute it. “Many buybacks take place over an extended period of time, and so the effect is also felt after it is complete. If a buyback is executed in two months, then the effect will be more immediate,” he pointed out. A fund manager with a foreign fund house suggested that the lag effect may seem even more pronounced in recent times because companies in the midcap sector accounted for most of these recent buybacks. “Near-term fundamentals cause many investors to give these companies a miss, and the sentiment around mid-caps in general hasn’t been all that great. So, this may prevent any immediate upside,” he said, preferring to remain unnamed. Out of 125 companies which completed buybacks, 67 delivered positive returns within a 12-month period. The top decile of performers delivered a surplus return of 73% over 12 months, reason enough to hold on if you think you have a winner at hand.