Share Buybacks: Are We Getting Value For Money?

10th Dec '24 by Roland Head

26 comments 1026 reads

Share buybacks have become hugely popular in recent years. By buying back their own shares and then cancelling them, companies can engineer an increase in earnings per share in excess of any increase in total profit.

In theory, the resulting increase in both earnings and earnings growth will support a higher share price and a higher price-to-earnings (P/E) rating.

If carried out correctly, share buybacks can represent an attractive investment opportunity for a business and its shareholders. But as I’ll explain, this is not always the case. Other motivations may drive some executives’ buyback decisions.

The sums of money committed to buybacks are often large and can exceed the cost of a company’s annual dividend. This means shareholders are swapping potential cash special dividends for the less certain benefits of a shrinking share count.

I think it’s worth considering more closely what buybacks mean for shareholders and how we can gauge whether they are likely to represent an attractive use of a company’s capital.

Dividend vs buybacks

A dividend is a cash payment that you or I will receive in our brokerage account. This payout reduces the book value of the company in line with the amount of cash spent, but shareholders are no poorer. We have our share of this cash and can do with it as we wish.

A dividend is truly a return of capital to shareholders. The same description is often applied to buybacks, but I think this is somewhat misleading.

When a company buys back its own shares, it expends cash, but shareholders do not receive it.

In theory, the benefits of the buyback will mean that the remaining shares become more valuable, both in terms of their market price and their intrinsic value. However, reality often falls far short of this rose-tinted ideal.

Consider drinks giant Diageo (LON:DGE), historically seen as a good stock for long-term investors.

Between June 2021 and June 2023, Diageo spent £3.7bn buying back 98.8m shares at a weighted average cost of 3,708p. Very roughly, that was about 160p per share, equivalent to a yield at the time of about 4.3%.

Shareholders could have received that cash, but they didn’t. Today, the company’s shares are trading over 35% lower, at 2,335p.

Diageo’s net debt has risen by around £2.7bn…

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doctor dave

11th Dec '24

This is normally declared at the time but my experience is that at times it can be deliberately opaque. Cancelled shares do reduce the total share count yes.

Silverback01

Insightful piece, Roland. To me buybacks often feel like a poor substitute for dividends or growth investment. They risk rewarding exiting shareholders or boosting executive metrics, rather than creating tangible value for long-term investors. In many cases, I find them underwhelming and have even seen share prices decline as a result.

BnB

Probably a controversial observation in the light of other comments, but I’m all for share buybacks. They halve the tax payable on the alternative and are an effective DRIP scheme. Big Ashtead (LON:AHT) USD 1.5bn buyback announced today is just what I wanted to see after a frustrating TU. It expresses confidence in the future and increases the value of my holding should growth re-accelerate.

Sometimes they don’t work in the short term, as the share price continues to fall. But you always have the option to sell the company at any point to halt the drift. And at a higher SP than if the buyback had not occurred. And stop kidding yourselves. Do you always get it right when you reinvest dividends from one company in another? Pick winning businesses that grow over the long term and their buybacks will reward you.

If you don’t like them then you’re probably investing in the wrong company/market for buybacks to work, ie ex-/low-growth UK options. Fortunately, we all have a choice.

ken mitchell

It’s not a controversial observation BnB as buybacks are very popular, and many just take it as read that they work well.

Re your “sometimes they don’t work in the short term” comment; often they don’t work long term either. And if we invest in successful businesses that don’t opt for buybacks we can win big with those too. I like well managed Companies that invest in the business successfully rather than spending that money on buybacks.

Finally to your claim that the share price will be higher than if no buybacks had occurred. There’s no evidence to support that comment. Buybacks are not factored in when buy and sell prices are being set and then fluctuating throughout the day. They can’t possibly be.

yiannos1

Well balanced article.

BnB UK investors will never understand the value of buybacks unless they turn their attention over to the US , where real growth profitable companies execute them. Apple (NSQ:AAPL) amongst hundreds of others have their share count slashed by half over the last 10 years!

What exactly is a dividend? Nothing else but a board of directors telling their shareholders that they cannot use that cash for growth!

Not sure if it’s Goldman Sachs (NYQ:GS) that has a detailed explanation about how British American Tobacco (LON:BATS) have waisted all these dividends instead of choosing buybacks , explaining that the price should have been X5 by now.

Across the pond if a company opts for a dividend instead , it is regarded as a sin! And they have shown as the last 20 years how proper value is created for shareholders.

All the best

Yes.Apple (NSQ:AAPL) is an example of well executed buybacks. So is Next (LON:NXT.

It’s wrong to claim that all buybacks are bad.

It’s just as wrong to claim that all dividends are wrong too.

Look at Games Workshop (LON:GAW) . They paid £4.10 in dividends this year. The share price was only a bit over that £4.10 just 8 years ago. Anyone who bought then (I did but sold far too soo) now gets almost 100% reward from dividends every year!

AND the Games Workshop (LON:GAW) share price has multi bagged 30 times in just 8 years to the current £140. 30 bagging share and a 100% yield.

Please tell us what is wrong with that yiannos.

Here’s the dividend data link for GAW’s dividends:-

https://www.dividenddata.co.uk...

I think the performance of shares like Games Workshop (LON:GAW) makes a nonsense of your claim that “dividends are nothing else but a board of directors telling their shareholders that they cannot use that cash for growth.”

John Lee, the first ISA millionaire, holds shares paying him more than 100% a year in dividends.

Finally the big Mining Companies used to spend multiple £billions buying back their shares. That was ahead of the extraordinarily severe Mining bear market that ended in 2015 that saw their shares fall as much as 80% despite those huge buybacks. So they now go for dividends and big special dividends in the good years and not buybacks.

Rusty2

How do you know, what the share price would be, if the company had not done the buybacks? If they pay out a dividend then the share price falls. I don't think they should do buybacks if they have high debt.

The large US stocks do backbacks and their shares have soared and they pay no or little dividends.

John LA

Couldn't agree with you more, often used by directors to increase their chances of a bonus. Ineffective mgt in my view

I do wonder in todays markets with EFTs and trusts being challenged with redemptions that buybacks are a way of reducing sell overhangs quicker

Nurzel

Great article and very insightful and practical. Only one question: What’s the rationale and justification for using 8% ERR and not some other number? Is there any underlying math that derives the 8% for Next that would allow us to calculate the equivalent figure for any other company?

WarrantStar

Unless the RNS makes it clear that the shares will be cancelled, it is very likely that they will be given to the directors. Occasionally they might be given to all employees as part of an employee share ownership plan.

Whitbread (LON:WTB) announced a share buyback on 16 October, 2024 the share price went up about 8% that day and then rose on the following days. The shares will either be cancelled or held in treasury.
The share price has fallen back since. I was looking to sell anyway, l managed to get out near the peak, so if the rise was solo due to the buyback, then that was better, for me, than paying it out as a dividend.

Trident

Shareholders and indeed management can't be always confident spare cash will be used wisely to invest. A number of companies in the tech sector grow by acquisition, and this is a potentially fraught area of expectation, as many will have experienced in some individual companies. Turnover growth is cold comfort when profits are damaged.

As in all things it depends on a balanced approach. Assuming a company is not increasing its share count, and therefore not really relying on the markets to raise capital, but is both investing its cash in its operations, and rewarding its investors in the meantime, that seems a happy medium of sorts. With lower interest rates momentum is maintained by dividends in a slightly stalled market.

Are dividends stagnating the dynamism of the UK market? Its certainly an interesting talking point.

RJS89

8% is close to double the rate of what a AAA rated bond would have paid you over 10 years (and by extension 30 years), historically

the historical rate being 4.3%-4.4% for US treasuries. the UK's is - IIRC, don't quote me! - closer to 4.1%-4.2%

(although the UK is no longer AAA rated lolol)

but yes, that would be my guess. 8% return on share buy-backs gives a chunky margin of safety (ben g. approved) over buying AAA sovs./govs.

Toweller

On Aviva (LON:AV.) and possibly Legal & General (LON:LGEN) and other insurers which are paying big dividends, if their cost of borrowing is less than the dividend yield, would it not make sense to buy back, as it would reduce the total cost of capital (at least in the short term and assuming capital cannot be used for growth)?

"The shares will either be cancelled or held in treasury."

This is the annoying part. Cancelled is fine. Held in treasury is not fine as they are likely to be exhumed for directors' benefit later - definitely not for shareholders

Some companies operate in areas where growth is harder and for them dividends make sense

rmillaree

Whitbread (LON:WTB)

any reasons for selling Rusty2?

I have been buying in at 2900 or below - with very little debt and great brand and great tnav backing - this seems a very very defensive share at present to be buying into.

I guess p/e is probably about 13 now and forecasts have been dropping and may drop further if they have cost issues (NI hikes) - so perhaps one can get in cheaper and perhaps whilst trend in expectations is downwards i am somewhat going against the flow here - but its still chunky profits being made and to me with such little debt they should have plenty of excess cashflow to pimp up returns even if organic profit growth is anemic.

Brilliant Leader

Thanks for a fabulous article Roland on an important topic which I see has also prompted some high quality discussion. Personally, I’m not a fan of buybacks most of the time but I accept there is a valid counter view.

Moreover, I wish there was a way that we could save articles like this for easy reference in the future but alas, I fear it wil get lost in the ether.

roddy10

15th Dec '24

I am a believer that the board of a company should publish their estimate of intrinsic value and hence should whether a buyback is accretive or not.

I think too many boards / managements bamboozle with 'it is accretive' with a lack of evidence.

Furthermore using debt to fund a buyback increases leverage and risk and therefore the equity risk premium for the company should go UP and hence the valuation ought to go DOWN. Surprising how many boards do not seem to realise this.

Companies tend to finance acquisitions and pay for dividends with debt when rates are low and liquidity is plentiful. When things reverse however they often find that they lack the financial headroom and the cheap funding that their strategy was dependent on.

I think that looking too intensely at the US is inappropriate. The behaviour / reaction to dividends and buybacks is also driven by tax structures (dividends are taxed higher than capital gains - and there are state as well as federal taxes to consider). It gets more complicated in the US for a whole variety of reasons but the bottom line is that long term capital gains are a lot more attractive.

I think in the UK with the recent changes in capital gains tax and dividend tax rates we may face investors wanting more buybacks.

If I have looked it up right: US ordinary income tax is 39.6% at the highest rate vs 20% for capital gains.

In California the highest state income tax rate is 13.3%.

So a Californian high net worth would pay circa 52.9% tax on dividends whilst on CGT it would be 20% (and obviously the individual decides when he or she needs the money).

See https://en.wikipedia.org/wiki/... and https://en.wikipedia.org/wiki/...

There may also be county income taxes (or City) in some counties see https://taxfoundation.org/rese...

[Note I am not an expert on US Taxes]

Share buybacks: are we getting value for money?

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Roland Head

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