Monday, 10 December 2012

Learn to Invest - EV, Buyback and Open Offers

The world of finance is filled with incomprehensible jargon which is difficult to understand by the common man. We have tried to simplify concepts and terms in our blog so that our readers can understand the important concepts and terms. We believe that with better understanding, the journey of learning to invest in stocks is made a lot easier.

Continuing on the same lines we bring about some more terms which we think will go a long way in learning about stocks and stock markets.

Enterprise Value :

It is the value of the company based on the company’s market capitalisation, debt on Books, Cash and Cash Equivalents (CCE)

EV = (Market cap + Debt) - CCE, (No. of Shares * CMP + Debt) - CCE

EV of a company is the value that an organisation has to pay when acquiring a company.

As an example lets say that there are two companies having exactly the same market cap and same CCE. One company has zero debt and the other has some debt. The company having zero debt has more value for the purchaser than the company having some debt. The company having zero debt thus has lower EV which favours the value buyer.

EV is a very good yardstick to compare two companies operating in the same sector. As investors we are not directly affected by EV but it gives more clear indication to the company’s valuation in the sector. This is one of the many parameters on which to judge a company and should be read in conjunction with other parameters that we discussed in our section on Learning to Invest in stocks .

Let’s continue. Recently the business news has been filled with companies offering Buyback offers and Open offers. We thought it is a good time to discuss this too. So here goes...

Buyback of Shares :

Company buys back its own shares directly from shareholders or from the market, generally at a higher price than the CMP.

  • After buyback, the number of marketable company shares is decreased. Such repurchased shares will not be a part of company’s networth & share capital.
  • Buybacks are executed by using shareholder equity/cash surplus/cash reserves of the company.
  • This is another way of rewarding shareholders instead of paying dividends.
  • Buybacks are generally perceived as company’s belief in its business model and is thus a sentiment lifter for the investor.
  • Since the outstanding shares are decrease after a buyback, and the EPS of the company share increases.
  • Buybacks attract Securities Transaction Tax (STT) like any other trade in shares.

Reasons for buyback of share :

  • Company believes in its business hence increases its promoter equity holding indirectly.
  • Buybacks are generally offered to support the share price thus increasing the company’s purchase value.
  • Companies float buyback offers to avoid possible hostile takeover bids.

Open Offers (Purchase) :

Purchase of shares by a promoter in the company from common shareholders for raising their stake. The offer price is generally higher than the CMP. It is an off-market transaction which is done to increase the stake in the company.

  • Open offers do not have any effect on the share capital of the company.
  • Open offers do not affect the EPS.
  • Open offers are off-market transactions. After purchase the number of  floating shares in the market is reduced.
  • Open offers attract long-term capital gains tax.
  • Unlike buybacks, open offers don’t have any effect on the networth of the company.

Learning to invest in stocks is easy when you know how to understand the various facets of the company and the market dynamics. The parameters of the stock and terms used to describe the company’s financial value go a long way in understanding and judging the company before you put your money there. RupyaGyan will continue to give you tips and advice on how to spot the right stock.

We hope that learning about stock markets has been and will continue to be an enjoyable journey for our readers and will help them invest in good stocks.