Why buybacks are losing their magic touch

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26 Aug, 2025 12:21

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Shishir AsthanaMoneycontrol Research 

The debate that is going on in the US for the last two years has reached Indian shores. Chairman of capital market regulator Securities and Exchange Board of India (Sebi) Ajay Tyagi raised the issue of the high amount of share buybacks being issued in India as compared to the amount raised through initial public offerings (IPO).

Reports say that over the last two years money given back to investors through buyback of shares by companies is more than the amount raised via fresh share issues. Last year companies returned Rs 33,931 crore, its highest ever numbers, through a buyback while in the current year to date Rs 23,495 crore has been returned. This year’s number does not include the Rs 13,000-crore buyback announced by Infosys. Including Infosys’ buyback, the current year will be a record year for buybacks.

During this same period companies have raised Rs 38,224 crore through IPOs. But Rs 50,000 crore of new issues is lined up and registered with Sebi, which might tilt the needle in favour of IPOs.

However, the point made by Tyagi is a valid one. Since 2010-11 investors have received Rs 75,415 crore through buybacks while Rs 101,686 crore has been raised through IPOs. The IPO data includes offer for sales by private equity firms, which like a buyback offer is money returned to the investor.

In recent years the rise in a number of buybacks is on account of companies in the IT sector returning the money back to investors. Some funds have been pressurizing companies to return the money back to shareholders if there is no requirement for funds by the companies. Ex-promoters of Infosys have also made a big issue over cash lying in the company which they feel should be returned to the shareholders.

Investors like a buyback as it offers a short-term opportunity to make money. Also, companies generally announce a buyback at a premium to their current market price. For the long-term, too, the impact is felt as equity capital gets shrunk since companies have to extinguish the shares that have been bought back, but this is effective only if the company manages to show a higher growth rate.

A high-pitched debate is raging in the US on the utility of buybacks. Average buyback per annum in the US over the last few years has been to the tune of USD 500 billion, that’s like buying back 25 percent of entire Indian market in a year (market capitalization of all stocks traded on the NSE is around USD 2,015 billion).

For the most part of the 20th-century buybacks in the US were deemed illegal because they were thought to be a form of stock market manipulation. Only in 1982 did the US legalise buybacks and ever since they have been gaining in popularity.

Legendary investor Warren Buffett is being credited for being a big votary of buybacks. However, Buffett had highlighted conditions for buybacks which has conveniently forgotten. In his 1999 letter to Berkshire Hathaway shareholders Buffett had said: "There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds—cash plus sensible borrowing capacity—beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated."

While most of the companies in India meet the first condition – of having sufficient cash, the second condition of buying it below the intrinsic value is generally overlooked. Indian laws allow a company to buy a maximum of 5 percent of the equity through a buyback in a year. Companies, mainly in the software sector, use this limit to prop up their earnings per share (EPS) by a similar amount. An organic growth rate of 8-9 percent in profits helps the companies post nearly 14-15 percent EPS growth. This growth rate keeps the investors and promoters happy.

But on a more basic issue returning money to the shareholders at prices above the intrinsic value destroys shareholder value in the long term. It also reflects that the management of the company either is devoid of ideas to utilize the money or they do not see opportunities for growth in the foreseeable future. Both these scenarios do not augur well for the shareholders.

In the US these issues were raised so that the money could have well been used for innovation and improve competitiveness. Indian IT companies are near the bottom of the innovation chain; their shareholders have more reasons to complain than the US investor where companies are already near the top end of innovation. Innovation is considered to be a high-risk business, but companies sitting on cash have the risk capital in place to venture in these areas.

Markets seem to have seen through the game of companies. The share price of many IT companies is trading well below the price at which buybacks were announced. Internationally, too, buybacks have lost their magic touch. Companies are being pulled up for ‘wasting’ money in buybacks. Take the case of Hewlett-Packard which in the last decade invested USD 47 billion in stock buybacks — which is nearly double the company’s current market cap.

Indian IT companies, too, are headed the Hewlett-Packard way unless they realise it is genuine earnings that will take their share price higher rather than jugglery like buybacks.