Infosys today rose over 3% and through the day, remained in the green.

Oh yes, the market is enthused alright! What has almost become a yearly ritual, Infosys has once again announced a buyback.

It has announced that its board will consider a buyback programme and payment of special dividend, among other proposals, at its meeting on January 11.

Last year, Infosys had bought back 11.3 crore shares at Rs 1,150 apiece (unadjusted to 1:1 bonus shares), amounting to Rs 13,000 crore.

As at 31st March 2018, promoter holding was 12.91%, which came down to 12.82% at end of Q2FY19, which is where it currently stands too.

If one may recollect, at the beginning of current fiscal, in April 2018, the shareholders had approved a capital allocation policy of the company wherein it sought to give back around Rs.10,400 crore to the shareholders, before the end of FY19.

This is a global phenomenon which Indian IT companies are emulating. Last year, TCS bought back Rs.16,000 crore worth of shares; HCL Tech bought back shares worth Rs.4000 crore and Wipro was the first, it had announced buyback to the tune of Rs.11,000 crore.

The IT companies are doing what bigwigs like IBM and Apple, Accenture and the rest are doing. Warren Buffett’s company, Berkshire has not declared a single dividend since 1960 but yet shareholders flock to hold shares in this company? Apart from the fact that it is a Warren Buffett company, he has helped created wealth for his investors – through consistent buyback of his own shares. And while Buffett discovered buyback way back in 1962, we in India remained obsessed with dividends.

So is this buyback a good deal? Better than dividend? From a wealth creation point of view, yes, buyback leaves you with more. Let us consider a hypothetical example. Let’s assume name of the company as Vava Voom Ltd (VVL), listed on the BSE and NSE. VVL has an equity of 50 crore shares and is trading at Rs.20/share, giving it a market capitalization of Rs.1000 crore. In FY18, it has a revenue of Rs.10,000 crore and net profit of Rs.100 crore. EPS is at Rs.2 and PE is at 10. And in FY18, being its 100th year of existence, the company gives out its entire net profit, Rs.100 crore to the shareholders.

If this Rs.100 crore was given out as special dividend, the 50 crore shares would each earn Rs.2/share. Suppose Mr.Tinku owns 1000 shares, he will get Rs.2000 as special dividend. As this is nowhere near Rs.10 lakh, this income will be tax free for Mr.Tinku. But for one promoter, who owns 6 crore shares, it would mean dividend income of Rs.12 lakh. Thus he will pay a tax of Rs.1,20,000, getting an after tax income of Rs.10.80 lakh.

And now suppose Rs.100 crore was used by the company to buyback shares. This buyback will happen over months and if from the open market, at different prices. So let us assume that VVL buys back 5 crore shares at Rs.20/share. This means that its outstanding equity or floating stock has reduced from 50 crore to 45 crore shares. Due to the reduced floating stock, the worth of Rs.20/share automatically goes up. Mr.Tinku will anyway remain a gainer but the promoter, if he holds this bought stock for more than one year, will save on capital gains tax. So how does he gain? In FY18, let’s assume there is no change in earnings and net profit comes in at Rs.100 core. The EPS will now be Rs.2.22, up from Rs.2 without adding any profits or growth. And if the PE also remains the same at 10, it means, stock price has gone up to Rs.22.22.

Thus the promoter is the big gainer – without doing anything but merely buying back, he manages to improve the EPS of the company and increase his stake. Mr.Tinku is happy that EPS is up but he does not really gain anything if he does not participate in the buyback. But if he sells his share, assuming he purchased it at Rs.20, his gain will be Rs.2220. If this is being sold within a year of his purchase, he will attract capital gains tax of 15%, meaning his post tax earning will be Rs.1887.

Buyback is a great tool for the promoters to improve their wealth – where CEOs and management pay is linked to stocks – stock options; thus buyback is a good way to boost their own income. Also by increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly EPS targets.

More importantly, cash which can be used for creating growth, either through acquisition or by ploughing back to fund capex plans, is now being diverted to buy back shares. How is this growth accretive?

Buyback to some extent is good but consistent buybacks do not add value to the company. Extremely cash-rich companies like Reliance can afford to do that but not when cash is low and buyback is done using debt.

As we always say, everything in moderation is good – even dividend and buyback.

PS: Infosys is not only going to buyback but also declare a special dividend. Now that’s a win-win!