Share buybacks

[MithrilVest]

If this is better suited to one of the other Basement forums please move.

I'm curious as to what folk here think about share buybacks?

Personally, I don't like them, I feel it shows that the management of a company have no ideas on how to grow it. I also feel that buybacks are used to artificially inflate certain financial metrics which means that management are more likely to get performance bonuses which are often tied to those metrics. For example, all things being equal, EPS will increase if a company buys back (and cancels) shares as the same earnings are now divided over a smaller number of shares.

Typically buybacks are spun as 'returning money to shareholders', arguably that is true in that, again, all things being equal it should increase the share price. But it's not a direct return to shareholders in the way a dividend is. Personally I'd prefer they announced a special dividend, even if that might not be quite as tax effective for all shareholders (tax on income different to capital).

Anyway, that's not really why I made this post  

Thought experiment - if a company continues buying back shares it will eventually own all the shares that exist, at that point who owns the company? Is it the board? The Chair? The CEO?

 

[Frank Hovis]

I like them because it is an efficient usage of capital.

I worked for a German reinsurance company, we were expected to produce a certain return on our capital.

If we thought market conditions were good and we could profitably expand then we could ask for, and be given, more.

If we thought market conditions were right then we could return capital and so be required to make a smaller profit.

Sometimes the best strategy for a business is either treading water or contracting, constant growth may simply grow losses.

 

Legal & General is a good example of a company pissing money away which they ought to just return to shareholders by buybacks, they've lost some huge sum, £100m or more, on their MMC (prefab buildings) factory and I read recently they had another new venture.

It's like John Lewis seeking ever more new and creative ways to set fire to their capital.

[Guest]

8 hours ago, MithrilVest said:

Thought experiment - if a company continues buying back shares it will eventually own all the shares that exist, at that point who owns the company? Is it the board? The Chair? The CEO?

In theory it should be mathematically impossible for the company to buy all its own shares I think. Since equity is the difference between assets and liabilities you can't put equity into the assets column. Maybe if equity hit zero but in that case the company is supposed to wind up.

[Democorruptcy]

I don't like the way they are done now. If it was a case of firms doing well and having lots of spare cash with nothing to spend it on, then it would be OK. In reality firms with huge amounts of debt do it to inflate share prices because executive bonuses are aligned to the share price. It's pure Ponzi. I'd prefer money spent on things to grow the business where possible, to create more income streams. Then increase the dividend payments, lots of firms now doing buy backs aren't even increasing the dividend by inflation.

Finally getting some criticism:

Quote

 

“Used badly, [buybacks] can be used to manipulate [earnings per share] numbers upwards to meet medium-term management incentive targets at the expense of investments that might be important to a company’s long- term health,” he said.

Daniel Peris, a fund manager at Pittsburgh-based Federated Hermes, called buybacks an “environmental hazard”.

“The dividend is just the dividend: grandma benefits, the long-term holder [benefits]. Buybacks benefit traders, hedge funds, senior executives [and] near-term share prices.”

Leigh Himsworth, a UK equity fund manager at Fidelity, said: “As a shareholder you feel like you never actually get the reward” with buybacks. “If the market is nonplussed by it then, as a shareholder, you are worse than square one, as the company has typically used up their cash.”

Abrie Pretorius, a manager at Ninety One, said: “Buybacks only create value for remaining shareholders and strong relative performance when shares are cheap and there are no better uses of that cash which would generate higher returns. Most buybacks help optical [earnings per share] growth but destroy value.”

Buybacks also do not always translate into better share price performance. An Invesco fund that tracks the price of companies that do large buybacks has underperformed the US market over the past decade.

https://www.ft.com/content/eaa1a31c-580c-405b-b438-a59504198ac8

 

 

 

[Frank Hovis]

On 19/05/2023 at 18:36, Darude said:

In theory it should be mathematically impossible for the company to buy all its own shares I think. Since equity is the difference between assets and liabilities you can't put equity into the assets column. Maybe if equity hit zero but in that case the company is supposed to wind up.

 

True that you can't have zero shares because then there is no owner but equity isn't just share capital, there are several equity accounts with main one being the retained profit and loss account, also share premium and as many individual reserve accounts as you want.

In some sectors even debt, long term secured borrowings rather than overdrafts, are classified under equity as being the major part of how the business is funded.

[wherebee]

Aren't share buybacks also a reaction to government mismanagement of incentives?  If tax on profits is too high (see oil companies), they buy back share to drive down end of year profits which sidesteps the taxes?

Or have I misunderstood?

[DoINeedOne]

On 20/05/2023 at 08:29, Democorruptcy said:

I don't like the way they are done now. If it was a case of firms doing well and having lots of spare cash with nothing to spend it on, then it would be OK. In reality firms with huge amounts of debt do it to inflate share prices because executive bonuses are aligned to the share price. It's pure Ponzi. I'd prefer money spent on things to grow the business where possible, to create more income streams. Then increase the dividend payments, lots of firms now doing buy backs aren't even increasing the dividend by inflation.

Finally getting some criticism:

 

 

I agree. Been reading up and learning more on buybacks lately. one reason I can see them not raising dividends is investors seem to panic when or if they need to cut the dividend back in the future.

Whilst share buybacks can stop and start and don't seem a major issue to most

The problems are most use them when share prices are high, and management uses them to benefit themselves. As you said, they are linked to bonuses etc..

 

An example I found whilst browsing the subject

When health insurer Humana Inc reported worse-than-expected quarterly earnings in late 2014 – including a 21 percent drop in net income – it softened the blow by immediately telling investors it would make a $500 million share repurchase.

In addition to soothing shareholders, the surprise buyback benefited the company’s senior executives. It added around two cents to the company’s annual earnings per share, allowing Humana to surpass its $7.50 EPS target by a single cent and unlocking higher pay for top managers under terms of the company’s compensation agreement.

Thanks to Humana hitting that target, Chief Executive Officer Bruce Broussard earned a $1.68 million bonus for 2014.

Edited May 23, 2023 by DoINeedOne

[DoINeedOne]

On 21/05/2023 at 07:37, wherebee said:

Aren't share buybacks also a reaction to government mismanagement of incentives?  If tax on profits is too high (see oil companies), they buy back share to drive down end of year profits which sidesteps the taxes?

Or have I misunderstood?

In most cases, it seems that it benefits management see the example above, but they can be positives too, just rarely the case

[Frank Hovis]

45 minutes ago, DoINeedOne said:

In most cases, it seems that it benefits management see the example above, but they can be positives too, just rarely the case

 

One example I knew, and used to work for, was a huge US insurer / life insurer which  sold themselves to pension funds and other investors as a steady safe growth stock.

And this precisely what the share price showed with near mathematical increases.

The group had a policy of annual share buy backs in order to achieve this, zero to low in a good year and high in a poor year.

This steady pattern of growth gave them a premium above similar shares as so many institutions wished to hold them.

There was nothing underhand about these buybacks, it was their explicit policy and it was explained to us in a presentation after they took over the group I was working for.

 

[reformed nice guy]

I think there are tax efficiencies for American investors. Broadly, capital gains are taxed lower than dividends for Americans

[MithrilVest]

Sorry for the delay in response, mostly read on my tablet and don't like posting from that....

Some good points made - thanks.

@Frank Hovis I definitely agree a share buyback programme is preferable to 'pissing it up the wall' on whacko ideas, but I'm sure most businesses could make some internal investments to make things more efficient, higher quality etc. Whether those internal improvements can soak up the amount used by buy-backs is, of course, a different matter.

You mentioned it was an 'efficient use of capital' - can I ask why you say that?

@DoINeedOne Agree it benefits management, many have bonuses tied to EPS, reducing the number of shares via buybacks is one way to increase EPS (but that seems akin to 'letter of the law rather than spirit of the law'.

@Darude Think you're right! Now I have thought about it more, theoretically you'd get to the point where the final share would be worth the sum of the company and so it wouldn't have the ability to pay for it.

 

My perception, and I've not analysed things so this is just my perception, is that share buybacks are far more common than special dividends and what I'd like to know is why. Share buybacks are meant to increase the share price but companies like Shell have spent many billions of dollars on share buybacks and the share price barely moves:

 

 

[Frank Hovis]

7 hours ago, MithrilVest said:

@Frank Hovis I definitely agree a share buyback programme is preferable to 'pissing it up the wall' on whacko ideas, but I'm sure most businesses could make some internal investments to make things more efficient, higher quality etc. Whether those internal improvements can soak up the amount used by buy-backs is, of course, a different matter.

You mentioned it was an 'efficient use of capital' - can I ask why you say that?

 

Within a group - you shunt the capital around the group to where it will make the greatest return.  I was working for a London subsidiary and we knew that we coudl have as much capital as we wanted (from memory we were on £50m but stepped up to £100m) as long as we coudl make a return on it.  If we couldn't then cancel the shares and pay the money back.  This was isnurance which is a veyr cyclical market.

For a plc - it is providing a return to its investors in a very tax efficient way, if you increase their wealth by paying dividends then they are taxed that year, if instead you buyback shares then they have a cpaital gain and can realised thta whne they want.

 

Ventur Capital Trusts - these are a perfect example of efficient use of capital though it doesn;t take the form of share buy backs, this is because VCT dividends are usually ?always tax free so there is no tax benefit form a buy back.

A VCT invests in start up / early years / small comapnies with the proceeds of share issues.  Whenever it makes a sale or brings a company to market the proceeds go back to the shareholders as tax free dividends.  When it wants more cash to make new investments it makes a new share issue which investors can buy with the cash they have from their dividends (I used to recycle them this way) and then the investor receives tax relief of rthe new purchase.

It is a beautiful example of efficient use of capital combined with taking full advantage of the tax legislation.

 

[AlfredTheLittle]

On 21/05/2023 at 07:37, wherebee said:

Aren't share buybacks also a reaction to government mismanagement of incentives?  If tax on profits is too high (see oil companies), they buy back share to drive down end of year profits which sidesteps the taxes?

Or have I misunderstood?

I don't think buybacks impact tax because they have nothing to do with the trade and do not impact the taxable profit; the funds for the buyback would be from after-tax cashflow. Which does seem to make buybacks pretty silly in the case of Harbour Energy for example, as effectively each share they buy is costing 4 x the market value. If they make £1 profit, they pay 75p tax and have 25p left for buybacks, so they would surely be better off finding other ways to spend the money.

Edited June 3, 2023 by AlfredTheLittle