Record level of share buybacks
Share buyback programmes may well be enjoying unprecedented popularity, but their benefits are increasingly being called into question. In recent weeks and days, several stock market heavyweights have announced plans to buy up shares for treasury. Best Buy, a US electronics chain, announced a US$ 3 billion programme on 28 February. On 1 March, Lloyds Banking Group said it would be spending up to £1.75 billion on buying its own shares. Fresenius Medical Care, Shell, Swiss Re, Allianz, Softbank, Novartis, Intershop, Glencore and AkzoNobel are just some of the many other companies that are launching or expanding their buyback programmes.
There is no doubt that such programmes are popular. But they have also recently come in for criticism. In mid-February of this year, a New York Times article written by Democrat senators Chuck Schumer and Bernie Sanders triggered a debate about share buybacks. The authors set out numerous arguments why share buybacks were damaging the US economy and why legislation should be introduced to curtail them. These arguments were plausibly countered by, among others, New York economics professor Aswath Damodaran and Linde Supervisory Board chairman Wolfgang Reitzle. The conclusion is that share buybacks can be beneficial to a company and its shareholders, provided certain conditions are met.
2018: a record year for share buybacks
Unsurprisingly, the phenomenon of share buybacks has its origins in the US. Listed companies there have been using such programmes since the early 1980s as a way of rewarding their shareholders in addition to paying a dividend. The volume of share buybacks has also been rising steadily in other regions, such as Canada, Europe and Japan, since the 1990s. In 2018, the total volume of buybacks by the companies listed in the S&P 500 index reached a record high of almost US$ 700 billion. This is due in no small part to the recent corporate tax reforms, which resulted in huge amounts of foreign profits being repatriated to the US. To put that into context: German companies spent €8.6 billion on buying back their own shares last year.
Share buybacks can boost earnings per share
Contribution to returns in the S&P 500
(Contributions in the years 2011 to 2018)
Contribution to profit growth in the S&P 500 (%)
Taxation is not the only reason for the increasing popularity over the years of share buybacks in the US and elsewhere. Under a company’s dividend policy, it makes sense to maintain a generally stable level of annual dividend payments over the long term – or at least not to reduce such payments. After all, shareholders do not like it when the dividend fluctuates significantly, especially if it is lower than in the previous year. However, companies need flexibility because their profits vary from year to year. A share buyback is therefore always advantageous for a company if it has a one-off amount to distribute. For shareholders, however, the company is sending a signal that it has only limited faith in the sustainability of its own profits.
Corporate America has the highest buyback rates
The statistics show that the US companies with the highest share buyback rates are large, long-established firms in the tech and pharmaceutical sectors. These companies have a high proportion of intangible assets on their balance sheets and spend a relatively substantial amount on research and development. They generate significant cash flows from their core business and are now passing on some of this cash to their shareholders by buying back shares. During the last four years, for example, Apple has purchased around 20 per cent of its own shares; IBM has reduced the number of shares outstanding by 50 per cent over a 25-year period. The top ten US companies for share buybacks in 2018 included Exxon, Microsoft, Oracle, Cisco, Walmart, Wells Fargo, Pfizer and Procter & Gamble. At the bottom of the list are firms in industries that traditionally pay high dividends, such as utilities, commodity producers and real estate companies. Share buybacks are less common among such companies.
US share purchases at almost-record levels
Top 500 US share buybacks
(Percentage of market capitalisation)
Breakdown of buybacks by sector (%)
When a company repurchases shares, the number of shares outstanding in the market decreases. Earnings per share will therefore go up (all other things being equal). That is why the share price tends to rise when a buyback programme is announced, i.e. it is a kind of technical effect. The reasons for running the programme are crucial to assessing whether it is a good idea:
Is the objective to minimise the cost of capital? Given the low yields on corporate bonds, this was certainly one of the motivations for many company bosses in recent years. From the shareholders’ perspective, this financial decision was indeed beneficial because it minimised costs and increased earnings per share. The effect was exactly the opposite for bond investors, although it was offset by the improved fundamental prospects for business and the low level of interest rates.
Is the objective to maximise the remuneration of senior management? Company executives often hold shares themselves or are paid in the form of share options, which means they benefit from share buybacks. If this is the case, shareholders should scrutinise the situation and, if necessary, bring about a change of practice by engaging with the company.
Is there a lack of alternative attractive investment opportunities? Alarm bells should ring in this situation, because it suggests that the company has only limited growth prospects.
Summary: brisk activity in the coming weeks
In conclusion, share buybacks per se are not a bad thing. They can be a useful component of a shareholder value policy, provided that the company can actually afford to implement its share buyback programme. However, if they are being used only as a way of boosting the share price quickly and will lead to an irresponsible rise in the company’s leverage, such programmes should be viewed with scepticism.
Share buyback activity is likely to remain brisk over the coming weeks and months. The end of the reporting season and the improbability of a sharp rise in yields on corporate bonds are likely to prompt companies to continue repurchasing shares in large volumes. There is also a lot of M&A activity. These factors are providing good support for the equity markets at the moment, despite the softening of the economy.
Unless otherwise noted, all Information and illustrations are as at 01. March 2019.