Before we start with the crux lets us understand whats is buyback and why companies do a buyback.
When a company earns a hefty profit and willing to pay their shareholders from the part of the earnings they can distribute the profit via Dividends and Buyback of shares. There is a calculation methodology of taxes on dividend and buyback which is a long go to understand and will be writing in some other day. So now let’s understand in the layman terms what is dividend and Buyback means to shareholders.
The dividend is the small part of the amount companies distribute to its shareholders from its reserves.
You can consider dividend likely as interest from Fixed Deposit similarly companies pay a small amount to its shareholders which are called as a dividend. Unlike Interest in FD, Dividends are not compulsory for the company to distribute to its shareholders. No growth or mature companies provide regular dividends to its shareholders while growing companies reinvest the amount of money in the business and less focus on the dividend.
Let’s consider one example -“News Headline-‘Sun Pharma Board approves a 200% dividend’.”
Now you will be feeling dubiety that sun pharma has declared a 200% dividend but here is the catch whenever a company declares a dividend first look at its face value of the shares, for here it is 1 rupee face value per share so you will receive only 2rs as a dividend per share and so on.
Buyback of shares is the companies buyback the shares from the existing shareholders at a certain price which is higher than the current market price. ( in tender route)
Buyback of shares is approved by two routes 1) Tender Route 2) Open Market Route So let us understand both the ways
- Tender Route
Tender Route is the most common way for the buyback. In the tender route the current shareholders have to make an application for the buyback of shares and on the basis of the demand and company buybacks on the pro-rata and quota allocation basis i.e Acceptance Ratio.( we will see further)
2. Open Market Route
The open market is a simple and easy one. The company buyback the shares from the exchanges and complete the buyback process but due to such a heavy demand in the shares the price shoots up if the company has a less free float and substantially it will lead to buying at a very high cost then expected and this can make a buyback process costly.
Let us also understand the Announcement Date, Record Date and Ex-Date
Announcement Date= Date at which the company make the announcement for buyback of shares.
Record Date= Date at which company records the shareholders who will be entitled to the buyback.
Ex-Date= After this Date nobody is entitled to participate in the buyback.
(Our all examples are based on the basis of announcement date for the simplicity purpose and our examples don’t have any record date till yet( except Thomas Cook)).
Let us understand how the buyback process works and how we can earn some handsome profits out of it
So let’s go step by step to reach and understand in a smooth manner. Example-Justdial
Just dial Board have just approved the buyback on 30th April 2020. ( want to see the notification Please Click here) alternatively, you can visit the BSE website search for Just dial and you will get all the information of buyback in the corporate action section.
Step 1- So as to discussed above visit the BSE Website and In the corporate action, you will get Buyback details ( Link already Attached).
Step 2- Try to Get the 3 details from the announcement shared by the company. 1) Buyback Amount ( Total amount of shares they are going buyback) = 22 Crs 2)Buyback Share price( what rate they are going to buy one share ) =700rs 3)Total shares buyback ( No. of shares they are going to buyback)= 3142857
Step 3- Get a Theoretical Buyback Ratio= Divide the total shares for buyback/ total Number of shares Outstanding. i.e 3142857/64903692 =4.84%.
This explains the total per cent of shares they are buying back from the market ( This info. is available in the announcement given by the company. Please visit the above link for more details)
Step 4 – To maximize the profit from the buyback we try to focus on the retail quota for the time being. ( Retail quota=SEBI mandates companies to set aside 15% of the total buyback size for retail investors, these investors are those who are holding shares worth up to INR 2 lakh on the record date of the buyback process i.e you can maximum buy 526 shares at CMP of 380). We have 15% of the Quota reserved for the retail shareholders.
So let’s calculate.
We can see that 471428 Shares are applicable for the buyback for the retail Shareholders( 15% of 3142857 which is 471428)
Now how do you know how many shareholders are falling into minority shareholders which can apply to retail Quota? Here is the catch you can get a shareholding pattern in the annual report which shows how many shares are under 1-5000 Category, 50000-100000 Category and so on. you can See in the below image that 1720248 Shares are under 1-5000 Category that means these are shareholders who may apply for the buyback in retail quota. ( You can Download annual report form BSE Website or Company’s website)
Step 5- Now we have to find the acceptance ratio so that we can get a clear picture of what % the company will accept our shares
Acceptance Ratio= Total Shares are available for retail Quota/ Total No of shares held under minority category which is =471428/1720248 = 27% (Minority means under 5000. Please view the above image) So 27% is the minimum acceptance ratio by the company for the buyback of the shares.
Step 6- Scenario Analysis
Worst Case= Only 27% Shares Tendered for the buyback and 73% shares remain untendered which we will exit at cost( as we assume the worst scenario).
So we invested 1,99,880rs for the buyback. Now we have only 27% of the acceptance Ratio that leads to 142 out of 526 of shares can accept in the buyback and 384 remains untendered.
142 shares are sold at 700rs per share ( Buyback price decided by the company) and remain we sold at the cost (the price we bought) then also we can see that we have made a good chunk of money i.e 45,446 in the invested amount of 1,99,880 and made a handsome profit in the buyback period. So as we calculated the worst-case scenario similarly we will calculate the base case and best case scenario
Base Case= Only 45% ( this assumption made by us) shares tendered for the buyback and 55% shares Untendered which we will exit at cost. The most important in the buyback process is the share price and the assumption of acceptance ratio for the buyback process to understand an make a calculative assumptions
Why base case and best case scenario appears in the picture because even though we consider the category of under 5000, not all shareholders are below 500 shares which fall under retail quota and not all shareholders under minority will be applying for the buyback and we have already been conservative in terms of a worst-case scenario( all minority shareholders apply for the buyback)
Best Case=Only 60% (assumption made by us) shares tendered for the buyback and 40% shares untendered which we will exit at cost. So what amount of profit is made in the Best case Scenario.
So we can analyse that in the worst case Scenario we are earning ~23% in the buyback Period( which is mostly 2-3 months of duration) and in the best Case Scenario we are earning ~51% profit for the buyback period.
Mistakes an Individual makes:
So we have just considered all the prices on the announcement date and maximization of profit at the current scenario but well you should also know that the company records the data on the record date and what will be the current market price at the record date we don’t know and due to volatility if your value of total shares will be more than 2 lac then you are no more applicable for the retail category and you will be considered in HNI( High Net worth Individuals) category and no longer this profit will be applicable. So for simplicity always buy your stocks in 1.5 -1.8 lac value so that you will be protected somehow but buying exactly for 1.99 lac will be a risky side.
Many Companies throw out the cash Via Buyback but we have to assure that the buyback is a good opportunity or not. As we can see the example of Just dial, it is 1 in a Million opportunity where we can make a massive amount of money. While before applying for the buyback please follow the steps provided to value the buyback and don’t lose the opportunity cost in other terms. Let us discuss one more company i.e Thomas Cook. Let’s See how much Viable it is.
Share Price as on 49.35 ( Announcement Date). We can see the Acceptance ratio is 19.34 %.
Let’s see the scenario analysis for Thomas Cook.
We can see that in the worst-case scenario we can just make 3.14% of the profit while in the best case scenario we can make 3.8% profit. Now at this point of time due to low acceptability and due to high opportunity cost, we will try not to participate in such a buyback Scenario.
In the concluding part, we can say that don’t participate in the buyback which looks lucrative on the price as you can see that in Thomas cook that the buyback prices are lucrative i.e 57.5 but the acceptance ratio is way too bad and so retail investors can make a minor loss( Due to volatility) or cannot make some good chunk of money from this buyback.
So always have a buyback analysis step by step provided above so that you can play a safe bet and earn a lot of money in an example of JUST DIAL and capital can be protected while investing in a better outcome.
Thanks for reading,