HALFWAY THROUGH | H1 2024 RECAP
In equity markets, particularly the US S&P and Nasdaq, most of the heavy lifting has been done by ‘big tech’ but the outlook for the broader market has improved.
Share Buybacks: a Financial Maneuver With Multifaceted Implications
Andrew Mobsby, Head of Technical
In the ever-evolving world of finance, share buybacks have emerged as a prominent strategy employed by corporations. These involve a company repurchasing its own shares from the open market, effectively reducing the number of outstanding shares. This seemingly simple transaction, however, carries far-reaching implications for investors, the company’s financial health, and the overall market landscape.
Delving into the realm of share buybacks unveils a multifaceted phenomenon that has sparked both ardent support and fervent criticism. Proponents tout the benefits of enhanced shareholder value, increased earnings per share, and a bolstering of stock prices. Opponents, on the other hand, raise concerns about potential market manipulation, diminished investment in growth opportunities, and a widening gap between corporate profits and employee compensation.
Repurchasing shares is just one way a company can return excess cash to shareholders, and often makes sense.
ADVANTAGES OF BUYBACKS:
- Increase the share of ownership of each shareholder. If a company with 100 outstanding shares repurchases 10 shares, the remaining 90 shares will each represent 1.1% of ownership.
- Increase earnings per share (EPS). When net income is divided by a smaller number of shares, the EPS increases.
- Buybacks can return cash to shareholders when the company doesn’t have a compelling way to invest it.
- Share buybacks are more flexible than regular dividends. However special dividends can also be used to make ad hoc payments to shareholders.
- Buybacks can be used to offset the dilution of stock-based compensation.
VISA: An example of where these buybacks had a significant effect on EPS is VISA. Over the past 10 years, VISA bought back 18% of outstanding shares. The result was that while net income increased by 218%, EPS increased 289%.
WHEN BUYBACKS ARE NOT A GOOD IDEA:
- Buying back shares instead of paying down debt can have long-term consequences for shareholders.
- Buying shares when they are overvalued. Like with any other investment, this can eventually lead to losses.
- Buying shares to support the share price. This excess cash would be better spent on operational improvements rather than supporting the share price.
- Company management are sometimes incentivized to repurchase shares to reach certain benchmarks that determine their own compensation. This can occur when the price is too high or paying off debt would make more sense. Personal greed and self-reward at the expense of shareholders!
Navigating the intricacies of share buybacks necessitates a balanced perspective, acknowledging both the potential benefits and inherent risks. While these repurchases can indeed enhance shareholder value under certain circumstances, they should not be viewed as a panacea for corporate success. It usually just takes a bit of common sense to tell when a buyback plan doesn’t make sense.
