The 30 major companies doing £8 billion of share buybacks, and why they’re doing it
The City is calling it a Buyback Bonanza in 2021.
Both Unilever and Diageo have announced they are buying back their shares to the tune of billions of pounds.
Research shows major UK companies have announced plans to buy back more than £8 billion of shares so far this year.
Of the 30 top names, some of the UK’s biggest companies feature, ranging from BP and Standard Chartered to Barclays and Balfour Beatty.
But what do buybacks mean, who does them and why?
What is a share buyback?
When companies have built up a lot of spare cash from selling their products and services, they have three choices; invest it in something new that will hopefully generate more profits further down the line; keep it for a rainy day; or hand it over to shareholders.
If they choose the latter, they can either give it to the investors as cash – usually done as a dividend – or they can do it by spending the money on buying back the company’s shares from the investors.
What’s the point in that?
A share represents a slice of the value of a company. If you reduce the numbers of shares in issue, theoretically each share should be worth a bit more.
Also, it means that the big institutions get cash back for their shares when the company buys them. They can then invest that money elsewhere to get a higher return.
Generally, a company will tell a broker to go into the market and buy up a certain amount of stock, generally from the big City investors. UBS is doing the deed for Diageo.
Retail investors don’t generally have their stock bought back but they do benefit from the appreciation in the share price and a bigger share in the future dividends.
Why are so many buybacks happening now?
Through the Covid crisis, companies cautiously held onto as much cash as they could to get through the economic calamity brought on by the pandemic.
Many held back on paying dividends to investors, or reined in their spending on marketing, research and development or takeovers.
Now there seems to be an end in sight to the pandemic pain, those who can’t think of anything better to do with the cash are handing it back to shareholders.
Russ Mould at AJ Bell says super low interest rates are also driving the buyback trend: “Low interest rates mean firms are not gaining a decent return on any liquid assets,” he says.
Does the share price always rise when buybacks happen?
Not necessarily. BP has been doing them for years and it’s had little impact on the price, although you could argue that it’s impossible to say exactly what influences a share fluctuation. It’s possible BP stock would have fallen further if it had not been buying some of it back.
How should investors interpret a share buyback when considering a company?
Views are different. Most investors see them as a sign of confidence coming out of a recession, in that it shows management are less cautious about holding onto cash.
AJ Bell’s Mould says buybacks may also suggest management considers the shares are too cheap. After all, everyone in business wants to buy low and sell high. It is, then another vote of confidence in the company.
But it can also suggest management has run out of ideas about where to invest. That can be an indication either of unimaginative management or a boring, low growth industry. It could also mean management is risk averse, which could be a good thing.
E-commerce player The Hut Group this week issued new shares to expand its fast growing operations. That diluted existing shareholders but the stock rose because investors hoped the company would be worth more in the long run as a result of the deal.
Fast growing companies, particularly in tech, will often issue new shares to raise to cash because there is so much to go for in their markets to boost future profits. The slice of the pie may be thinner, but the pie itself will be larger.
Any other implications?
Yes. Buybacks have come in for criticism because management teams have been accused of using them to juice up their bonuses.
Some bonus schemes are based on earnings per share (EPS) of the company. EPS is a measure where you take the total profit made by the company and divide it by the shares in issue. Naturally, if you reduce the number of shares that are out, hey presto, the EPS rises.
Some investors see buybacks as a form of financial engineering rather than improving the actual operations of the company and investing for solid, long term growth.
There is also evidence to suggest that, while management teams may think the shares are cheap, buybacks are generally done during bull markets when shares are actually at their highs.
More than £10 billion of share buyback plans were cancelled in 2020 when shares were probably at their cheapest. Buybacks done in, say, March last year would have been at rock bottom prices, producing a maximum EPS boost.
AJ Bell also warns that some companies are under so much pressure to give back cash to investors that they go into debt to fund the buyback. That could destabilise the business.
So, be wary of companies who buy back shares at any price, preferably setting a maximum they are prepared to pay and explaining why, and be cautious of those who do buybacks when their debts are high.
Diageo is quite highly indebted and its share price relatively fully valued, some analysts have warned. While the shares shot up more than 3% today, some of that could have been due to big profit upgrade it also announced rather than solely the buyback plan. It remains to be seen whether the buyback alone is a significant factor.
Mould says the final word should go to Warren Buffett, the so-called Sage of Omaha who, with his sidekick Charlie Munger, has been beating the markets for decades: “Charlie and I favour repurchases when two conditions are met: first, a company has ample funds to take care of the operational liquidity and needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.”
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