Don't just take buybacks at face value... they may be costing you a fortune!
A main role of a listed company Board is capital deployment and allocation:-
It must tackle operating performance, it must fund organic growth/working capital/capex, and must also take investment decisions, on acquisitions & disposals.
And if it succeeds and matures, then the company's financing decisions move to distributions to shareholders via:-
Generally, buybacks seem popular among commentators, as shown
“buybacks make a lot of sense financially. Whittling down a company's equity base automatically increases earnings per share. “
Financial Times 17 Feb 2011
“Share buyback a welcome surprise” ... “the main highlight was the announcement of a £150m share buyback programme. At c6% of market cap, this should be 3 –5% earnings accretive.” US Broker’s research commentary on a listed company announcement
The trend of late has certainly been for buybacks to exceed dividends as a mechanism for capital returns (with a small hiccup in the wake of the global financial crisis):-
The reasons buybacks are almost invariably viewed as good include
– the EPS boost (A dividend reduces eps (since the money which would otherwise earn a return on capital leaves the balance sheet, and the eps divisor stays constant, whereas a buyback increases the eps (by dropping the divisor)).
–it provides a "floor" under the share price which "must benefit shareholders"
– it is a sign of management confidence
But there is scarce a mention of price or returns
It certainly looks plausible – if a company in SA can borrow at 9% (taxed cost of 6.3%), it means it is “right” to do a buyback if the earnings yield exceeds 6.3% (ie PE ratio is below 15.9X). But it can in fact harm shareholders’ returns!
As an example Pepsico bought back shares in 2008, and reported a higher ROE of 34.83% up from the 2007 figure of 34.53%. So shareholders should have been happy, right? But a more conservative interpretation I suggest here would have the company rather keeping the bought back shares in its calculations:-
2008 as Published Suggested
Shareholder‘s equity 12,203 12,203
Add back repurchased shares 4,720
New 2008 shareholders equity 12,203 16,923
2007 shareholders equity 17,325 17,325
Average equity 14,764 17,124
Profit 5,658 5,142
Plus: profit attributable to shares repurchased 220
New profit figure 5,362
ROE 34.83% 31.31%
Share count 1602m 1670m
EPS $3.21 $3.21
So as you can see the EPS result is the same, but the decline in ROE is masked by the buyback as reported!
So the widely stated view that “the way in which cash is returned to the shareholders is irrelevant” (FT Lex column 8 Jan 2010) is wrong –Buying back shares when they are not cheap destroys value for remaining shareholders
Why then has it become so popular? Look at this table showing a static company which makes a billion rand each year, and which over a decade elects to buy back 10% of its shares each year.
What has the buyback achieved? EPS growth of 11% per year, compounded, which has thus given the market the option of getting a rising shareprice out of a flat market cap performance. But what else - it has catapulted the value of the directors' option pool, which had "zero" value at issue, up to 9.3% of the company! So the buyback initiative has a different effect on the parties! In essence, the company sold shares at 100 to the options pool, then is buying them back at well over R200 - following a "sell low & buy high " strategy to transfer money from its shareholders to its option holders!
Still happy with buybacks?