How share buybacks can boost shareholder wealth.

Let’s say a listed company has done well over the past year. It may have lifted its sales or revenue, cut expenses or done both. And the bottom-line profits have grown.

Clearly that is the objective. But now the company has to decide how to reward its shareholders - those who have had faith in the direction and management of the company. At the end of the day, the company is owned by its shareholders.

So the company now has a decision to make. Does it plough the money back into the business by buying or refurbishing equipment or premises? Perhaps it goes on the takeover trail.

Certainly a common way that companies reward their shareholders is to pay them a dividend. And the shareholders then have the option of taking the payouts in cash, or perhaps reinvesting the proceeds in the company or buying shares in other companies.

What is a share buyback?

But there is another option available to listed companies. Companies can buy back shares from their shareholders. The intention being to take the shares out of circulation – the company electing to hold or cancel the shares with the aim of boosting the share price.

This is fundamental economics at work. Supply & demand influencing price. Fewer shares available, means a reduction in supply. Now if the company performs well – and importantly this performance is expected to continue – that may lead to more demand for the fewer shares in circulation. The end result being a higher share price, boosting wealth for the company’s shareholders.

Why do companies launch buybacks?

Some companies have gone down the route of buying back shares rather than paying out dividends to shareholders. Like Qantas. Qantas reported a record profit for the 2023 financial year but decided on a buyback rather than rewarding its shareholders via dividends.

But why buybacks? Why go down this route of rewarding shareholders as opposed to merger or acquisition, issuing dividends, or ploughing the money back into the business?

There could be many reasons. Takeover prospects may be thin on the ground. The outlook for the company may be uncertain, constraining growth prospects. Or the company may believe that its shares are under-valued. That is, future prospects are so good in relation to other firms, that investors will be keen to buy stock.

So, why buybacks? Should you participate in a buyback?

When companies undergo buybacks, this pushes money back into the hands of shareholders – in a macro sense, just like dividends.

But it’s important to note – unlike dividends – that there is no single day for the buybacks to occur. While dividends are paid out on a certain day, the buyback programs may apply for weeks, months and even years.

Now, as noted above, the other reason buyback programs are implemented is to lift the value of shares, providing a ‘wealth’ increase for existing shareholders.

But there are a number of ‘buts’. First, companies can suspend or cancel buyback campaigns with little notice. Companies can also scale back buyback programs.

Second, the aim of buying shares to boost the share price may not work. Circumstances may have changed, the outlook may have become cloudy, and investors decide to put funds to work elsewhere in the sharemarket or the broader economy.

Buybacks: different types; tax implications

Some companies are focussed on the number of shares it wants to purchase. Others have a certain value of stocks in mind. And the offer period can vary markedly. It just depends on the strategy being applied.

For instance, National Australia Bank announced that it will buy up to $1.5 billion of its own stock between August 29, 2023 and August 14, 2024. But James Hardie announced that it is looking to purchase 10.06 million of its own shares between December 12, 2022 and October 31, 2023.

And then there are ‘on market’ and ‘off market’ purchases.

An ‘on-market’ buyback is when a company offers its buyback to all shareholders. In contrast the company may offer to buy back shares of a select grouping of shareholders. This is termed an ‘off market’ buyback.

Investors may also have to consider the tax implications of selling their stock which will differ markedly from person to person. One investor may have purchased the shares when they were trading higher than now. Others may have bought when the shares traded lower than current levels. And ultimately, the capital gain or capital loss may have tax implications.

And this is where a financial advisor, tax expert or accountant may come in. It’s not just a matter of the net gain or loss, but how this affects the broader circumstances and financial strategy of the investor.

And so, at the end of the day a share buyback is just another issue that needs to be considered when it comes to investing in the sharemarket.

More Reading:

https://www.commbank.com.au/articles/investing/what-are-share-buybacks.html

Author: Craig James, Chief Equities Economist