Buyback: Mechanics and the Per-Share Effect

A buyback is a company spending its own money to purchase its own shares. The shares bought are cancelled or held aside so they stop counting. Cash leaves and the share count falls. Profit is unchanged and is now divided among fewer shares. Earnings per share rises. The company paid more for each share than the book value that share carried. Book value per share usually falls at the same instant.

Two things move in opposite directions in the same transaction, and almost every account of a buyback describes only the first of them. The rise in earnings per share is easy to state, easy to headline and easy to mistake for something the business did. The fall in book value per share happens at the same instant, sits in the same set of published figures, and hardly ever gets mentioned beside it.

Work out what physically happens first, then follow the money out of the company, then run both per share effects on one hypothetical buyback so neither can be quoted without the other, then read the balance sheet, the honest limit of what the action establishes, and the routes a buyback can take. A per share figure that has jumped can then be read straight away for whether the numerator moved, the denominator moved, or both.

Three things are settled already and are not rebuilt here. A share, and what a shareholder holds, is settled under shares and shareholders. The listed company, whose share count is a published number that can change, is settled under listed companies. The profit ladder and balance sheet that every figure below is read out of belong to the accounting layer, and are applied below rather than rebuilt.

What actually happens when a company buys its own shares?

Picture the simplest version. Sarvani Coatings Limited says it will buy 40,00,000 of its own shares and pay Rs 600/- for each of them. Holders who want the money hand their shares over. The company pays out Rs 240 crore. And then the part that makes this different from anything else that happens to a share: the shares the company has bought do not go anywhere. The bought back shares are cancelled, or held in a way that keeps them out of the count. Either way they stop being part of the 24,00,00,000 shares that every per share figure is divided by.

Bought back shares leave the count rather than passing to somebody else, and every effect below follows from that one fact. Consider what normally happens when a share changes hands. One holder sells a thousand shares, somebody else buys a thousand shares, and Sarvani Coatings does not notice. No cash moves in or out of the company. The share count is exactly what it was that morning. Millions of shares can change hands in a day and the denominator sits there untouched.

A buyback is the other thing. The company itself is the buyer, so its own cash goes out, and the shares it receives are retired instead of resold. Cash down, count down, in one movement. A buyback is closer to a shop taking a shelf out of its own storeroom than to a customer buying what is on the shelf.

One consequence follows immediately, and it surprises people. Every holding percentage is measured against that same count. The promoter and promoter group block of 52.4 per cent is 12,57,60,000 shares. The promoter block itself is unchanged by the buyback. But measured against 23,60,00,000 shares instead of 24,00,00,000, the same block is 53.29 per cent. A holder who did nothing at all comes out of a buyback holding a larger share of a smaller company. Nobody bought anything; the denominator moved underneath everybody.

Where does the money for a buyback actually come from?

There is no separate pot. A company running a buyback is spending resources it already has. In practice that means cash already on its balance sheet, or borrowing raised for the purpose. Nothing is created. A buyback is a use of capital in exactly the way a factory is a use of capital, and a company doing one has chosen it ahead of every other use, including the ones it never mentioned.

Here is the household version, and it is closer than it looks. A household has Rs 6,00,000/- saved. The household can prepay a chunk of the home loan, replace the scooter that is costing more in repairs every year, or put the money into the daughter's course fees. Whichever it picks, the other three stop being available. Nobody would describe prepaying the loan as free, and nobody would describe it as proof that the loan was a bad loan. Prepaying is simply the use that won.

Sarvani Coatings has the same shape of choice at a larger scale. At the end of year three it held Rs 312 crore of cash and investmentsMoney the company can reach quickly: bank balances plus holdings it could turn into money without much delay or loss. against total borrowings of Rs 240 crore. Spending Rs 240 crore on a buyback uses more than three quarters of that cash. The same Rs 240 crore would have repaid every rupee of those borrowings, with nothing left over and nothing left owing. Rs 240 crore would also have funded the unfinished coatings line, carried on the balance sheet under capital work in progressSomething a company is still part way through building. The spending has happened, the thing is not switched on yet, and until it is there is nothing to depreciate and no revenue coming off it. at Rs 118 crore, and then funded a second one just as large.

Why does earnings per share rise when nothing about the business has changed?

Earnings per share is a fraction. Profit after taxWhat is left of a year's profit once every cost, the interest bill and the tax charge have been taken out. The bottom line of the profit ladder. on top, shares in issue underneath. Sarvani Coatings earned Rs 278 crore in year three, and on 24,00,00,000 shares that is Rs 11.58/- a share. Now take 40,00,000 shares out of the bottom of that fraction and leave the top exactly where it was. Rs 278 crore over 23,60,00,000 shares is Rs 11.78/- a share.

Not one rupee of extra profit was earned, and the per share figure still went up: the entire movement came from the denominator. This is the most misread effect in the whole of this sequence, and it is misread by people who are perfectly capable of doing the arithmetic. The reason is that earnings per share is normally the figure an analyst reaches for precisely because a per share view of how the business did is what is wanted, so a series of them carries an unspoken promise that a change in the number means a change in the business. A buyback breaks that promise silently.

One small thing here catches people out. The count fell by 1.67 per cent, being 40,00,000 out of 24,00,00,000. Earnings per share rose by 1.69 per cent. The two percentages were never going to match. The first is measured against the old count and the second against the new, smaller one. A fall of one part in a denominator always produces a slightly larger rise in the quotient, and the two figures are the same movement described from opposite ends.

Why does book value per share fall in the very same transaction?

The fall in book value per share is the half that goes missing. Take it slowly. Book value per share is a fraction too, with net worthShare capital plus the reserves built up over the years, which lands on the same figure as everything the company holds less everything it owes. Often called shareholders' funds. on top, shares in issue underneath. A buyback shrinks both. The question is which one it shrinks harder.

Every rupee paid out is cash gone from the company. Net worth falls by the whole amount. Rs 1,486 crore becomes Rs 1,246 crore. The share count falls only by the number of shares the money happened to buy, and that number depends entirely on the price paid for each one. At Rs 600/- a share, Rs 240 crore buys 40,00,000 shares, and 40,00,000 out of 24,00,00,000 is a fall of 1.67 per cent in the count against a fall of 16.15 per cent in net worth. Divide the smaller number by the barely smaller number and the answer drops: Rs 1,246 crore over 23,60,00,000 shares is Rs 52.80/- a share, against Rs 61.92/- before.

The condition underneath is worth stating plainly, being a rule that carries to any buyback and not just this one. Book value per share falls whenever the price paid per share is above the book value per share, and it would rise if the price paid were below it. That is not a claim about Sarvani Coatings, it is arithmetic: buying a share for less than the book value it carries leaves more book value behind for each remaining share, and buying it for more leaves less. Here the company would pay Rs 600/- for something carrying Rs 61.92/- of book value, so the fall is not marginal.

Separately the two effects are two facts. Together they are the transaction. Now put both on one scale.

What does a buyback do to the balance sheet?

Three lines move and one of them does not, and the one that does not is what makes this interesting. Cash and investments drop by the amount spent, leaving Rs 72 crore of the Rs 312 crore that was there. Net worth drops by that identical amount, leaving Rs 1,246 crore of the Rs 1,486 crore. Borrowings do not shift at all, standing at Rs 240 crore on both sides of the transaction.

Now read the net position. Net debtBorrowings less whatever cash and near cash a company is holding. Where the cash is the bigger of the two the figure comes out negative, and the company is said to be in net cash. is borrowings less cash. Before the buyback that is Rs 240 crore less Rs 312 crore, or minus Rs 72 crore. Sarvani Coatings holds more cash than it owes. After the buyback it is Rs 240 crore less Rs 72 crore, or plus Rs 168 crore. The company has crossed from net cash to net debt without borrowing a single rupee, purely by spending the cash that was netting the borrowings off.

The crossing is a general point rather than a quirk of these numbers. Whichever way a buyback is funded, the net position moves against the company by the full amount spent: pay with cash and the cash side of the subtraction shrinks, borrow to pay and the borrowings side grows. Same arithmetic, same direction, same size. There is no funding route that leaves the net position where it was.

What does the whole transaction look like worked out on one company?

Here is the whole thing in one place, worked on the year three figures Sarvani Coatings Limited published. The company has run no buyback, so read the right hand column as what these particular numbers would become and nothing more.

Hypothetical throughout. Sarvani Coatings Limited has run no buyback and none is proposed. The price of Rs 600/- a share was picked so the arithmetic divides cleanly, and it is 23.5 per cent above the illustrative quoted price of Rs 486/- used across this sequence on its stated date. Figures are the invented year three set.

Read the table downwards once and the shape of a buyback is right there. The top line does not move. The second line moves a little. The third line moves because the second one did. The fourth line moves a lot, the fifth moves because the fourth moved much harder than the second did, and the last three lines describe a company that has spent three quarters of its cash. Every single change in that table is traceable to two things leaving, being Rs 240 crore of cash and 40,00,000 shares, and not one of them is traceable to anything the business did during the year.

Size it, too. Scale disciplines the reading. Rs 240 crore is 2.06 per cent of a market capitalisationThe quoted price multiplied by the total number of shares in issue. A market's arithmetic on the whole company on a given day, not a figure from the accounts. of Rs 11,664 crore. The 40,00,000 shares are 1.67 per cent of the count and 3.50 per cent of the free floatThe shares not held by the promoter group, which are the ones generally available to be bought and sold in the market. of 11,42,40,000 shares. A transaction at that modest size still walks book value per share down by nearly fifteen per cent.

What does a buyback prove about a company, and what does it not?

The honest version comes in two halves. A buyback proves the company had the resources. The money left, and it was the company's money. A buyback also proves the company chose this use ahead of the others. The others were available on the same day and did not get the money. The two claims are solid and can be relied on.

Now the half that gets over claimed. A buyback is frequently read as management saying the shares are cheap, on the reasoning that a board with better information than anybody outside would not spend real money above what it thought the shares were worth. The inference is tempting and the action does not support it. A company buying its own shares is not a neutral judge of what its own shares are worth, and companies have bought their own shares before at prices that later looked poor. The decision was made by people who work there, using the resources of the entity being valued, and that is a different position from a disinterested buyer.

Watch the specific trap in the Sarvani Coatings numbers. The hypothetical price of Rs 600/- is a premium to marketThe amount by which a price paid sits above the price the shares are quoted at, usually stated as a percentage of the quoted price. of 23.5 per cent over the illustrative Rs 486/-. A premium is easy to read as conviction. The same premium is at least as easy to read as the price at which enough holders were willing to part with their shares, a fact about the sellers rather than about value. Nothing in the announcement settles which. An announcement settles the size, the price and the route, and settles nothing at all about what a share is worth.

Which routes can a buyback take, and who gets the chance to sell?

A buyback can be run as an offer made to every holder, usually called a tender offerAn offer put to holders to buy their shares at a stated price within a stated window, which each holder can accept or ignore.. The other route is purchases made in the open market over a period. The conditions attaching to each, including who may run one, on what terms and within what limits, are set out in the Companies Act 2013 and in the buyback regulations made by the market regulator, and are read from those instruments directly.

The route changes who gets a chance to sell at all, and the difference to a holder is real rather than procedural. An offer put to every holder reaches the person with a hundred shares in a demat account they open twice a year. Purchases in the open market reach whoever happens to have a sell order in the market on the days the buying runs, and that is a very different set of people. A holder who was not watching is simply not part of the second one.

What happens if the size of the buyback moves?

Everything above is one setting of one dial. The panel below moves that dial and redraws all three effects together, so the two per share figures separate and the net position crosses the line in plain view. The panel opens on the worked buyback. Rs 240 crore spent, 40,00,000 shares bought, earnings per share of Rs 11.78/-, book value per share of Rs 52.80/- and net debt of plus Rs 168 crore. The table above carries exactly those figures.

Two settings of that panel are worth reaching. At a size of nothing, every bar collapses to the published figures, which is the honest baseline. At Rs 312 crore, every rupee of cash the company holds, earnings per share has still moved by less than three per cent while book value per share has fallen to Rs 50.00/- exactly and net debt now equals the whole of the borrowings. The dial that barely moves the headline figure is the same dial that moves the balance sheet a very long way, and that asymmetry is the finding.