Opportunity amid gloom

The sharp fall in stock prices is an opportunity both for investors and companies alike. While investors can look to pick up bargains in the market mayhem, listed companies have a chance to restructure their capital through share buybacks. Although the net profit growth for India Inc has, as a whole, slowed down in the last quarter, many companies continue to cruise along at well over 25%. Most such companies have rewarded their shareholders with handsome dividends. With the sensex coming down sharply from the near 13,000 levels, cash-rich companies can now think of share buybacks instead of dividends, to return cash to shareholders. Besides sending a strong message about valuation, this way of returning cash to shareholders is more democratic. Share buybacks, as opposed to dividends, have an element of choice. While dividends accrue to all shareholders alike, in buybacks only those shareholders who need cash would surrender a part of their holdings. To such investors, it would make no difference whether they get the cash through dividends or buybacks, assuming that there is parity in tax treatment. Investors who would rather see their earnings reinvested in the company than receive dividends would not participate in the share buyback. These investors would also benefit, albeit indirectly, from the buyback in that their future earnings per share would increase because of the reduction in the number of shares.
For companies, share buybacks have an added use: capital restructuring. Through market purchase of shares with the cash that they would have otherwise returned through dividend, companies can change their capital structure. Under-leveraged ones can increase their leverage without taking on fresh debt. Yet others that have a high equity base can reduce their shareholder capital. This is particularly relevant for those companies that have seen substantial equity dilution though bonus issues. Lastly, in such choppy markets, buybacks would have a calming effect on share prices.


-- The Economic Times Editorial