Why TCS stock price jumped up 4% after buyback news?

Most of our indices fell down by 1% yesterday but TCS stock price jumped up by almost 3% and at one time traded as high as Rs 2,572. We all know that they released new information on 15th May about (Buyback) buying their own stocks and this activity will start on 18th of May and end by 31st May 2017.

There might be any questions popping up in your mind. Say for example, Will the stock price jump up to Rs 2,850 by the end of this month?

Why did the stock price jumped up by around Rs 100 – Rs 125 only?

Should I sell my stocks in this buyback activity?

Should I buy stocks of TCS during this buyback time to gain short term capital gains?

Well, by the end of this article you will have all the answers to your question. But before that let us understand what buyback means to the shareholder.

Buyback of shares

In simple terms this means company is buying back its own shares that it issued earlier to its shareholders.

Why will company buy its own shares?

TCS is sitting on a big pile of cash that belongs to its shareholders. As of 31st March 2017 there are 197.04 crore shares issued by TCS to its shareholder. Now that cash pile should be use to grow their business earnings and create value for the shareholders.

  1. They can invest this money on behalf of their shareholder in their own business to expand. This can be done by buying other companies where they can see synergy in growing their earnings.
  2. They can distribute this cash back to its shareholders through dividends, or
  3. They can buy back their own shares on behalf of their shareholders and raise stock value of remaining shareholders.

For various reasons they did not utilised this cash to invest or expand at similar or higher rate than their core business generates from its business activities. TCS ROE for 2017 stands at 33%. What this means is every Rs 100 invested by shareholders in this business had given back a return of Rs 33 to them in 2017. This is such profitable business and therefore sells at almost 6X to its book value today.

As the TCS business is so profitable, from many past years they were retaining almost half of their profits back into their business to utilise it for the expansion or to grow. This cash pile now represents almost 50% of what the money is contributed by its shareholders (book value). And from so many years this cash was generating returns of below 10% for its shareholder.

As the business by itself was so profitable, nobody cared about this low returns on their cash assets. Until that cash now looks like big mountain. The managers of TCS now realise that if they don’t do anything meaningful about this cash it will impact their returns and destroy shareholders value.

If investors are willing to pay 6X of book value for the business that is giving returns of 33%, they will definitely will not like to pay same for business reporting 25% return.

So the only option they have is to pay back this cash to whom it belongs without destroying business value. They can either pay back through dividends or buyback their own shares.

Paying hefty dividends will take many years and also damage the business value during that time. I have shared about this in dividend policy blog on TCS. The last resort remains is to buy back their own shares.

As mentioned earlier on top, instead of you buying that company share, the company buys them on behalf of its shareholder.

TCS buyback calculations

When do you buy any stock?

I am assuming you buy the stocks when you think that they are trading at cheap valuations and you see the bright prospects for that business in the future years.

In this situation, TCS did not found any other company to deploy this cash to invest then itself and is investing on behalf of you. So they think there is a bright future prospects of their own business. Who will know more about prospects than its managers? So there is no question to raise here.

But are they buying at cheap price?

They are buying these 5.61 crore shares of their own company for Rs 2,850 per share. Almost 20% premium to its last listed price before buyback. So if you got a letter from them saying they are willing to buy your shares. What I think you should do is sell it to them.

Why?

Well, this is not something first time happening in our market. Recently Wipro bought its shares for Rs 600 if you remember and its stocks were trading around Rs 540 in the market. What happened to its share price later on? It fell down as low to Rs 460 in few months and still trading far below that Rs 600 mark.

I am not suggesting similar will happen with TCS. If we get into the management shoe and think, why someone will be willing to sell you shares at market price? They need incentive to sell you today if you are coming out by yourself and saying there is a bright prospects for this business in the future.

Buying own companies stocks at premium price makes a short term illusion in investor’s mind that this company is worth Rs 2,850 and they start buying them. This helps in the short term for stock price to trade at premium price.

Valuations

So how do I know Rs 2,850 is premium price for TCS today?

If you are regular reader on our blog than you will recollect that just few days back we mentioned that TCS stock price looks cheap when it was trading at Rs 2,350 on 2018 valuations basis. We always recommend to buy businesses when they are trading within the expected intrinsic value band or below that band. Buy more when the stock price is close to the lower band and less or sell if you want to when it is trading close or at higher band.

TCS is expected to report profits for 2018 between Rs 25,970 crore and Rs 30,325 crore. The buyback activity does not changes this figure but it changes EPS and book value figures. So before the buyback its expected intrinsic value range was between Rs 1,927 – Rs 2,557 per share for 2018.

Buybacks always impact positively on companies valuations. So the new valuation range for TCS is Rs 1,986 – Rs 2,635.

TCS buyback price is far ahead of this range and thus looks expensive at this stage to us (This is only looking at 2018 valuations).

It is very critical to keep yourself up to date with the valuations. Because valuations of the business change, but not as fast as the stock price in the market. So Buyback activity of TCS has extended its higher band by Rs 78 of its 2018 valuations.

What are you doing with TCS shares if you own and you have got an offer letter? Share with us.