A share buyback, also known as a stock repurchase, occurs when a public company buys back its shares on the stock market. We will explore the many reasons why management decides to buy back company stock as well as its effects. In a way, stock buybacks work similarly to dividends. Investors can choose to sell their shares at a fixed price. Since the stock price also goes up, investors can take advantage of the rise to cash in some profits. However, share buybacks aren’t always well received by political parties or shareholders. Below, we’ll answer all the questions you have about stock buybacks.
What Is a Stock Buyback?
As we established earlier, share buybacks occur when top-level management receives shareholder approval to repurchase a certain amount of its shares for a fixed price.
Because the shares are no longer considered outstanding, the supply of the shares goes down, and it is believed the price of the stock will rise.
The demand for shares shouldn’t diminish. Let’s take a look at a few reasons motivating a stock buyback.
Belief In the Stock
Since the management is repurchasing the shares, they must believe that the stock will appreciate. In other words, they believe the stock is currently undervalued and will grow from that point on.
Existing shareholders should be optimistic that management wants to hold more stock. Potential shareholders may also take interest in the company and start a position if they believe the stock can grow and top-level management will make profitable business decisions. So a share buyback occurs.
Share Buyback and Cash
First, the company may have excess cash. Instead of carrying extra cash, it may be better to use it. Companies at the top of their sector or with no current expansion plans are good targets for a stock buyback. They are less likely to require financing and are well-established in their industry.
More on this later. On the other hand, those with plenty of room left to grow aren’t ideal candidates. They will likely require financing to grow or pay the debt. The cash can be used more productively.
Second, this means more cash for investors who choose to sell their shares back to the company. As we saw earlier, in a way it works as a dividend. This can also be more advantageous for investors since it isn’t taxed like a dividend. More money remains in your pockets.
Fixing Financial Statements
In some cases, a share buyback is used to make financial statements look better. Since the number of outstanding shares decreases, the EPS increases.
A higher EPS makes a company more attractive since every share brings more money.
Share buybacks can lead to more investors being interested in the stock in the short term. This increases the share price and shareholder’s equity. In the short term, the P/E ratio and ROE increase. When it’s time to release quarterly earnings, it can make the company look better than expected.
A Share Buyback with Stock Options
Stock options are a great way to attract talent in a very competitive market. Hence, buying back shares and offering them to promising employees as stock incentives can attract employees from competing sectors. It can increase the value of the company over the long run.
Stock buybacks also have their drawbacks. In the next section, we will explore different ways they can negatively affect concerned parties.
Disadvantages Of a Share Buyback
There exist many opponents to a share buyback. Instead of creating value for shareholders, company executives take advantage of the system to fill their pockets. Let’s take a look at a few examples.
Poor Use of Cash
We spoke earlier about using excess cash to buy back stocks. This can be a double-edged sword. It depends on the perspective of investors. Most companies can always put the cash into research & development, to acquire competitors or for more profitable use.
Where Do the Shares Go?
Share buybacks can easily be concealed as compensations for top-level management. Usually, shareholders must vote on the details of the buybacks. Shareholders aren’t always the winners when it comes to buybacks.
Recent administrations have tried to tax buybacks for companies to reduce corporate profits, but it remains unsuccessful. There should be a change in the next quarters regarding this issue.
Lastly, we also spoke about how stock buybacks can be used to fix poor financial statements. In other cases, companies use their loans to buy back shares. This was the case during COVID. In the next section, we will take a look at various stock buyback examples across time.
COVID & 2008 Recession
During the early stages of the pandemic, many companies received support from the government and were able to take out low-interest loans. As a result, they used debt to finance stock buybacks.
We can all agree that the pandemic hit many low-income families much harder than multi-national billion-dollar companies. Many companies and some shareholders benefitted in times of uncertainty.
The same companies were seeking bailouts during the pandemic, but had more than enough cash to carry on their business. However, pleasing shareholders is more important.
We saw similar actions during the 2008 recession. Governments bailed out many companies, mainly banks. In return, they did stock buybacks.
Ethically, I find it counterintuitive. Ultimately for shareholders, it was a positive stock movement and green days ahead. The majority of stocks involved in this section are already established in their sectors and the global economy. We’ll get more specific in the next sections.
Tech stocks are among the biggest spenders on a share buyback. Coincidentally, they are some of the biggest winners on the stock market over the last years. Which ones are on the top of the list?
Apple (NASDAQ: AAPL)
We begin with the all-time leader in stock buybacks. Apple’s market cap is steadily approaching $3T. It hit the $1B mark in August 2018.
Since then, the stock rose around 250%, but the market cap, less than 200%. In 2021 alone, Apple spent $85.5B on buybacks and $14.5B on dividends.
This is the perfect example of a company at the top of the food chain with tons of cash. Furthermore, I doubt any Apple investors are complaining about the company’s actions. However, the share count dropped from 19.4B to 16.4B in the last 3 years.
We can ask ourselves if it becomes sustainable for Apple for the decades to come. The company holds over $100B in cash, leading all stocks in the industry. Apple’s trend can easily last a few more years, but they might have to switch to dividends afterwards.
Microsoft (NASDAQ: MSFT)
Next on the list is the second-biggest spender on a share buyback. Microsoft’s cash position isn’t as impressive as Apple’s and neither is its buyback program.
Since 2012, Apple bought back $487.6B worth of shares while Microsoft is second with $147.1B. Despite the disparity, the company remains one of the most popular and successful on the market.
It benefited from similar gains and stock movements as Apple. Microsoft has been making significant acquisitions over the last years with GitHub, Activision Blizzard and many VR and metaverse platforms. This stock might be in a better position than Apple to become the market cap leader.
Banks & Financial Institutions
After many financial institutions defaulted during the 2008 pandemic, restrictions were put in place to limit their spending during another period of uncertainty.
Until the end of last year, both Canadian and US banks weren’t allowed to increase dividends or issue a share buyback.
Governments on both sides of the border wanted to prevent another wave of spending during a crash. After all, banks hold our money. If they default, we are in trouble. Since, stock buybacks increased among financial institutions and dividends are on the rise again.
Most Canadian and US banks are having record years despite the pandemic. Their cash piles are increasing. It’s no wonder they want to repay shareholders through stock buybacks.
All 6 Canadian big banks hiked dividends and stock buybacks at the end of 2021 and early 2022. Below are the four competing to be the best.
Bank of Nova Nova Scotia (NYSE: BNS)
Royal Bank of Canada (NYSE: RY)
TD Bank (NYSE: TD)
CIBC (NYSE: CM)
The US Side of a Share Buyback
On the US side, the 6 biggest US banks estimate they will spend 122% of their revenue on a share buyback as of July 2021 for the following 12 months. These banks include the following.
Bank of America (NYSE: BAC)
Citigroup (NYSE: C)
Goldman Sachs (NYSE: GS)
JP Morgan (NYSE: JPM)
Morgan Stanley (NYSE: MS)
Wells Fargo (NYSE: WFC)
During 2020, stock buybacks for S&P 500 companies were at a 10-year low. In the last quarter of 2021, they reached an all-time high. After the disastrous second quarter of 2020, they have been on a steady rise. However, times are uncertain once again.
The war between Russia and Ukraine is negatively affecting many sectors of the economy, inflation is leading to higher and higher prices and there is a shortage of many essential supplies. How will this affect stocks and buybacks in the near future?
Now You Know What is a Share Buyback
To conclude, a share buyback is very popular among top-performing public companies. We saw that tech stocks are among the biggest spenders, which correlated with their stock price increases.
However, governments are trying to slow down this program, or at least tax it more efficiently for companies. Many company executives are profiting instead of reinvesting it back into the economy or towards their shareholders.
For some, it is a poor use of excess cash. For others, it creates value for shareholders. Proponents and opponents exist on both sides and each has an agenda to follow.
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