Share buybacks: Are they a good sign or a waste of company money in 2023?

Nick Sundich Nick Sundich, May 23, 2023

Share buybacks are a controversial topic amongst investors. Some Concierge subscribers may be aware that Cyclopharm (ASX:CYC) unveiled one last week – we had a number of inquiries about it.

So, in this article, we recap what share buybacks are, some of the advantages or disadvantages and whether or not they are ultimately a good or bad thing.

 

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What is a share buyback?

A share buyback, also known as a stock repurchase, is when a company buys back its own shares from the public market in order to reduce the number of outstanding shares on the open market. This can be done for a variety of reasons including reducing the total number of common shares available and returning cash to shareholders.

 

What are some of the advantages?

One advantage of a share buyback is that it can increase shareholders’ value as the decrease in the number of available shares increases scarcity, which makes existing shares more valuable. Additionally, by buying back its own shares a company can signal to investors that management considers its stock undervalued and believes that their own future prospects look positive. This kind of move can help bolster investor confidence in the company’s outlook, leading to an increase in share price.

Furthermore, companies may use repurchased shares for purposes such as employee incentive programs or executive compensation plans, allowing the business to reward key personnel without having to issue additional stock options or pay high salaries.

Share buybacks also provide businesses with an efficient way to return excess cash to shareholders without having to declare a dividend. In this way, businesses don’t have to worry about taxation on dividends and instead can use share repurchases as a tax-efficient method of distributing profits back into shareholders’ pockets.

Finally, by reducing the amount of outstanding stocks on the market, companies are able to reduce their capital requirement and associated expenses such as accounting fees and audit costs.

 

What are some of the disadvantages?

One of the major drawbacks to a share buyback is the potential for creating an artificial demand and driving up the stock price. Share buybacks can push up the share prices by reducing the total number of shares available, which then makes each individual share more valuable. This in turn, can result in overvaluation of the stock and may not be beneficial to long-term shareholders.

Another disadvantage to a share buyback is that it could potentially reduce funds for reinvestment into research and development, for capital expenditure or perhaps for emergencies.

North American airlines were notorious for share buybacks prior to the pandemic – the four biggest US carriers (Delta, United, American and Southwest) spent US$40bn during 2015 and early 2020. But as travel demand sunk, they needed US$54bn in pandemic aid. As part of a condition for the bailout, there was a ban on stock buybacks until the end of September 2022.

Companies must think carefully about allocating surplus cash, as buying back their own stock might mean they are missing out on opportunities to expand their business or cash for a rainy day.

Furthermore, there is a risk that management might be tempted to purchase shares when they are undervalued due to a temporary downturn in financial performance. This creates a conflict of interest if executives are personally benefiting from such decisions and has implications for corporate governance.

 

Ultimately it depends from company to company

The most important thing is that companies are still ensuring they have money left for difficult times. As long as this is the case, share buybacks are generally a good thing for shareholders.

 

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