Buy Back Shares?

What is a Buyback?
Buyback is the process wherein a company offers to buy its shares owned by the investors, at a premium over the prevailing market price. The offer can be binding or optional to the investors. The trend of buyback offers is usually seen during the bear markets where the promoters feel the stock prices of their companies are undervalued.

The Company Can Buyback Shares From...
● The existing shareholders on a pro-rata basis or
● The open market through a book-building process/stock exchanges or
● Odd lots, that is from shareholders who own a small number of shares or
● The employees of the company pursuant to a scheme of stock option or sweat equity.

Why Companies Go For Buyback?
● Some companies buyback stock to contain the dilution in promoter holding and to block takeover bids.
● Buyback option is also exercised when a company has extra cash reserves and not many investment avenues.
● To enhance its performance metrics such as EPS, ROA and ROE etc and to maintain their target capital structure.
● To reward their investors, companies prefer buyback to dividends, as the dividend attracts taxes at both the company and the investor level.

Regulations For Companies
The government has imposed some restrictions on companies resorting to buyback to protect small investors and also to restrict them from using stock markets as a source of short-term profits.
● Buyback should not exceed 25% of the total paid-up capital and free reserves. While companies can buy-back shares upto 10% of its paid-up equity capital and reserves through a board resolution, companies need shareholders resolution to buyback anything above that.
● A declaration of solvency has to be filed with SEBI and Registrar Of Companies.
● The shares bought back should be extinguished and physically destroyed and the company cannot issue any further buyback upto six months. In a fiscal, the company can normally buyback upto 5% of its outstanding equity without notifying the regulators if the promoter’s stake ranges from 55% - 75%.

Checklist For Investors
While the buyback offers are good entry points for short-term due to arbitrage opportunities arising out of differential in the market price and the buy-back price, investors need to check the following reasons behind the buyback.
● If the P/E ratio of the company is higher than the industry average, the buyback by the company may not be justified. The investors should watch out if the buy-back is being done at the cost of capital expenditure, as it may dampen future prospects.
● The higher the price & the percentage of the buyback, greater is the scope of profits for investors.

The Final Word
Though buyback is an arbitrage opportunity in the short term, investors are advised to look at the company’s fundamentals as well as corporate governance practices before taking a call. One has to also see how many shares the company is buying back and the chances of implementing the buyback announcement as scheduled, without any delay/cancellation. If the company’s fundamentals, corporate governance are strong, the investors may have the advantage of immediate arbitrage and long-term growth potential for their capital.

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Auction Vs Discount

Do you get to buy the stuff that you would like to buy cheaper in an auction or in a discount sale?


Buying near the peak of the bull market is typically like buying in an auction, where the bidder who bids the highest price gets to own the shares that he or she bids! Conversely, buying near the bottom of the bear market would be like buying in a discount sale, in which one could get shares at a steep discount to its actual value.

In the bull market peak, while the market is going up most of the investors believe that it would continue to go up forever and are keen to participate in the expected gains. As more number of investors enter the market and the demand is much more than the supply of the shares, the market would witness an auction like scenario where the investors who quote higher prices get to buy shares in the market.

The ‘bigger fool theory’ is usually prevalent at the peak of the bull market. According to this theory, the
investors continue to buy stocks at higher prices with an assumption that they will be able to sell it later to "a bigger fool”; to be precise, buying something not because you believe that it is worth the price, but rather because you might be able to sell it to someone else for an even better price. At this stage, most of the investors get into the market with an expectation of immediate gains i.e. they expect to re-auction at higher prices at the earliest!!! While, most of the early entrants into the market do gain from the bull market, the late entrants typically tend to be stuck up with high priced stock whenever the tide turns. Most of the stocks bought at the peak, would be worth a lot less than the price at which they were bought.

This kind of behavior repeats at every market peak, as greed usually dominates the human behaviour during this period.

In a bear market bottom, investors tend to behave as if the market would continue to fall forever. Existing investors tend to sell stocks at less than their value, as they fear that the stock prices could fall further because the supply of the shares is more than the demand. New investors tend to wait further as they anticipate buying stocks at cheaper prices.

As the downside risk in equities is more evident in a bear market, investors tend to forget the upside potential of the equities. Investors should keep the long-term track record of the markets in mind, and not the immediate short-term track record of the market, which is usually quite volatile. To illustrate the long-term track record of the market, one can study the return given by the Sensex from its base of 100 on April 1st, 1979. In the last 30 years, the markets have given a 16.48% compounded return to investors. This is not taking into account the dividends that the investors had received and the tax advantages of long-term investing in equity. However, the returns were quite volatile in the short-term. For Example: the market lost nearly 52% in 2008 after gaining nearly 47% per year both in 2007 and 2006.

The fact remains that equity has been one of the most attractive long-term investment avenues. Though
in the short to medium term it is usually quite volatile, the longer the time frame of the investor, the lesser
is the chance of the downside risk in equities, if invested in quality stocks, especially in a bear market when the valuations are attractive.

In a bear market, investors should focus on buying quality stocks at a discount to their true value, but not
because they are getting it at a discount to the prices seen during the previous peak!

What do successful investors do? They usually tend to buy quality stocks in a discount sale and sell in an auction.

Tomorrow we will discuss about buyback of shares. Until then let us know how you feel about our tips and articles.

Should you Invest in IPOs - Investment in IPOs part 2

Welcome back to the ABCs of investing in IPOs. So how do investors protect themselves and take advantage of the IPO opportunities?

Dos:
● Do check the quality of the promoters before investing in the stocks. What is their track record? Are the promoters/management trustworthy? Did their other group companies that have earlier gone for IPO provide adequate returns to investors? At what price did the promoters and other investors invest in the company? What would be the promoter stake post the public issue? Whether they have any strategic/technical tie-ups or alliances with well-known companies etc.
● Do check the basic valuation metrics such as EPS, P/E, Book Value, Dividend yield etc. Has the company been able to increase its revenues and profitability over a period of time? What is the valuation of the company when compared to its industry peers?
● Do check, where would the company utilize the IPO proceeds and how would the company benefit by going for an IPO?
● Do check the future prospects of the company and whether the company can grow its revenues and profits, going forward.
● Do check the IPO grading: Before the issue, the issuing company needs to get itself graded by the credit rating agencies registered with SEBI. The grade represents a relative assessment of safety, return, risk of IPO vis-à-vis other listed equity shares. The higher the grade the better it is, though a higher grading would not guarantee any returns to investors, if the issue were expensive.

Donts:
● Do not invest in the IPO just because everyone else is doing it and you would not like to miss the opportunity. Remember that if more number of people applying (i.e. the demand is high) the price is usually not cheap and the possibility of making return post listing would also diminish.
● Do not invest in IPO with the hope of making instant return (especially if the IPO is expensive), because the ‘grey market (unofficial price)’ premium is high. This grey market premium is usually manipulated and it could (and most likely it will) change before the listing and the investors hoping to make a quick profit could end up making a loss.
● Do not invest because the current IPO is relatively cheaper than the listed stocks in the same space, if on absolute basis the stocks in the industry are expensive.
● Do not invest if there are significant risks in the horizon especially where there are execution risks, compliance risks, contingent or regulatory risks. As any developments on these fronts can risk the value of the investments in the company.
● Do not invest in IPOs if one is not ready to take the risks associated with investing in equity shares.
While the current regulations are tighter than in the past, and have resulted in the improvement in the quality of promoters that are accessing the capital markets to raise funds, investors need to be alert to the hype surrounding the IPO issues and focus more on the downside risks and potential returns based on the company’s valuation.

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Should you Invest in IPOs - Investment in IPOs part 1

Should investors invest in the primary market or the secondary market? Which would
provide investors better returns? What are the precautions that investors should take
while investing in the primary market IPOs?
Historically, the valuations have determined the kind of returns that investors would get
from a stock, irrespective of the fact whether the company is already listed or is a new
IPO. Investors have burnt their fingers while investing in stocks at the peak of bull
markets, whether they have invested in these stocks through IPO route or in the secondary
market. On the other hand, many investors who have invested in IPOs whenever the
stock is attractively valued have made good returns on their investments.
In the past, we have seen many investors investing in the IPOs, even though these IPOs
were expensive or the quality of promoters was suspect and thus losing money on their
investments.

Tomorrow, a peak at the Dos and Donts of investing in IPOs. If you think you need immediate advice on your portfolio management, don't hesitate to get in touch with us.

Weekly Market Outlook 12/07/2010

The market closed the previous week at a new 13-week closing high indicating that the current market sentiment remains robust. The Nifty is currently hovering the 2-year high level of 5400, a decisive move above these levels could result in Nifty rallying towards 5750 levels.

The market would be keenly watching the IIP data that is scheduled for release on Monday. While a positive number could propel the market higher, any negative surprise would hit the market sentiment.

The market would also be keenly looking at the monthly WPI inflation data and a fall in the inflation would help further reduce the concerns of more rate hikes before the RBI policy review meeting.

The market would closely watch the first quarter results season to witness if the current earnings growth momentum indicate any further upside in the market. Stock specific movements would be witnessed based on the results.

The market would keenly follow the outcome of the meeting of PSU refineries regarding the fuel price norms that is scheduled for July 17th and Oil & Gas space is expected to witness increased activity.

With Agriculture Minister pitching the decontrol of sugar prices, sugar related companies are expected to witness activity during the week to come.

The market is expected to continue to take cues from the global market and FII inflows. On the global front, the market would watch the US industrial production, jobless claims, etc to ascertain if the economy is on the sustained recovery path.

5277, 5210 and 5182 are the immediate support levels for Nifty, 5400, 5500 and 5545 are the immediate resistance levels for the Nifty.

17536, 17396 and 17277 are the immediate support levels for Sensex, 18048, 18274 and 18593 are the immediate resistance levels for the Sensex.

The market is expected to rally further once the Nifty decisively crosses the 5400 levels.

In case you missed this good story in Business Line today

Investing in stocks is the best bet to beat inflation

20-year analysis shows returns outstrip gold, bank deposits and commodity futures.

With prices rising at double-digit rates, where does it pay to invest? An analysis of stock returns over alternative avenues of investment such as gold, bank deposits and commodity futures shows that equities have been most successful in giving inflation-beating returns.

Over a 20-year period, according to the analysis, equities have managed a higher return compared to other asset classes during years of high inflation (Consumer Price Index in excess of 7 per cent).

The Consumer Price Index has been above 7 per cent annually in all the years since 1990. Equities have managed to out-perform other asset classes for six years during the period.

In 1991, when the Consumer Price Index rose above 14 per cent, equity investors made an 80 per cent return (measured by Sensex) on their investment. In 1997, when the CPI rose over 7 per cent, the equity market delivered a close to 20 per cent return. In 2009, when inflation was at a 10-year high of 11 per cent, investors could have raked it from the market had they only been venturesome enough.

Equities outperform

In the years when the inflation was over 7 per cent, returns from equities oscillated between 17 and 80 per cent. Adjusting for inflation, the real return has been at least eight percentage points higher. The reward for investing in equity has also widened in recent years.

An investor who bet on equities, rather than gold in the last five years, generated a 12-percentage-point higher return compared to the eight-percentage-point excess return in the mid-1990s. Needless to say, the equity returns are much higher than the returns on investments in bank fixed deposits too. Interest rates on fixed deposits have fallen sharply since the mid-to-late 1990s.

Gold was the second best choice for hedging against inflation in the last two decades. In 2008 and 2009, for instance, when inflation was over 10 per cent, gold yielded a 15 per cent return.

Gold as choice

Gold has caught investor fancy only in the last seven years. Perceived as a safe-haven in times of crisis, the investment demand for gold has been going up.

The data of the past 20 years, however, do not throw up any precise trend of gold being an out-performer in inflationary times.

Indeed if it outshone stocks, it was only when there were external shocks such as the one that happened in 1997, and more recently in 2008, when there was a crisis of confidence with the equity market across the globe. The conservative investors who preferred the fixed deposit route to investment saw negative real returns in most of the years of high inflation.

In 2009, the interest rate for deposits of one-to-three years was 7.25 per cent, with negative real return (factoring in the inflation rate) of 4 per cent.

This year, too, as inflation continues to remain at 12-13 per cent, bank FDs offer interest rates of 6-6.5 per cent.