Page 105 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes
which ensured that investors who had been holding the stock for several years received a
fair price for their investment.
Questions
1. What were the objectives of the buyback ordinance issued by the Government of
India in 1998? Describe the salient features of the buyback ordinance. Why did
MNCs want to buy back the shares of their Indian ventures? Explain.
2. The depressed stock markets in India are being utilized by several large MNCs to
increase their stake in their Indian subsidiaries through the buyback of shares.
Explain in detail the different methods of buyback available to an organization.
3. According to minority shareholders, MNCs had misused the buyback option. Explain
the various grievances of minority shareholders regarding the buyback of shares.
4. Do you think stringent measures should be introduced to protect the interests of
small investors? What should SEBI do to safeguard small investors’ interests and
resolve their grievances?

Source: www.icmrindia.org
Buyback may lead to abnormal increase of prices posing heavy risk to those who value shares
based on fundamentals. This may also lead to reduction in investor interest in the market
particularly with de-listing of good shares.

Example: It was feared in 2001-03 that de-listing by many MNCs may drop the money
flow to stock exchanges.

3.6.1 Reasons to Buyback

Unused Cash: If they have huge cash reserves with not many new profitable projects to invest in
and if the company thinks the market price of its share is undervalued.

Example: Bajaj Auto went on a massive buy back in 2000 and Reliance’s recent buyback.
However, companies in emerging markets like India have growth opportunities. Therefore
applying this argument to these companies is not logical. This argument is valid for MNCs,
which already have adequate R&D budget and presence across markets. Since their incremental
growth potential limited, they can buyback shares as a reward for their shareholders.

Tax Gains: Since dividends are taxed at higher rate than capital gains companies prefer buyback
to reward their investors instead of distributing cash dividends, as capital gains tax is generally
lower. At present, short-term capital gains are taxed at 10% and long-term capital gains are not
taxed.
Market Perception: By buying their shares at a price higher than prevailing market price company
signals that its share valuation should be higher.

Example: 1. In October 1987 stock prices in US started crashing. Expecting further
fall, many companies like Citigroup, IBM, etc, came out with buyback
offers worth billions of dollars at prices higher than the prevailing rates
thus stemming the fall.

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