INVESTING EXPLAINED: What is a share buyback, why do companies like them and do they help investors?
In this series, we bust the jargon and explain a popular investing term or theme. Here it’s share buybacks.
Why do firms buy back shares?
Dividends are forecast to be less generous this year. Link Group, the data business, predicts payouts will be £87.5billion, 7 per cent less than in 2021, a bumper year, following the pandemic dividend drought.
However, many billions are expected to be handed out in the form of share buybacks by such companies as BP, Shell, HSBC and Diageo.
The drinks maker is to accelerate its £4.5billion buyback programme.
Boost: Like dividends, share buybacks are a means of rewarding shareholders
How do buybacks work?
Like dividends, share buybacks are a means of rewarding shareholders, allowing them to own more of the business.
The company buys back some of its shares, reducing the number on the market, so potentially boosting the share price.
If there are fewer shares, this increases the earnings per share, which should be good for investors. This metric, which is used by many investors to assess the value of a share, is calculated by dividing the company’s net profit by the number of shares outstanding.
Are they becoming more popular?
Definitely. Companies that hoarded cash during the pandemic appear keen to distribute these funds. This includes the banks, which were prohibited from paying out dividends during that time.
Taylor Wimpey, for example, told shareholders this month to prepare for a £100m buyback. Shell’s $7billion buyback drive, funded by the sale of its Permian Basin business in the US, will continue this year.
US companies awash with cash, including many Big Tech names, carried out a record level of share buybacks in 2021, returning $870billion (£643billion) to investors in this way.
Why do companies like buybacks?
Paying a dividend is great but the risk is of having to cut it at some point, which will make you unpopular with shareholders. Reducing buybacks seems to attract less publicity, maybe because they are less well understood.
Is there a buyback leader?
Apple, which sits on a $196billion pile of cash, may be the buyback’s most enthusiastic proponent. Under its capital return programme, it spent $85.5billion on buybacks last year, bringing the total since 2011 to $467billion.
This strategy is apparently designed to underline the giant’s status as a ‘quality trade’ that is a solid and reliable enterprise.
Could anything stop buybacks?
There is mounting controversy over buybacks in the US. Some argue that they enrich executives if their bonuses are based on share price performance or growth in earnings per share.
Bosses are also being accused of opting for buybacks rather than embarking on long-term capital investment projects. As a result, President Biden is proposing to impose a 1 per cent tax on companies undertaking buybacks.