Share buybacks: a beautiful thing

[JoyofBrex8889]

All too often we see on these boards grumpy Fools whinging that a share buyback is taking place. The petulant mutterings usually go something like this: “Buybacks are reducing my dividend.... They used to be illegal...management want their share options to trigger”

They are, of course, entitled to their opinion.

No matter how wrong they are.

Shareholder returns are a combination of dividends and share price appreciation.

Now it is true that diverting cash from a dividend to a buyback is going to reduce income initially. However a share buyback is as good or as bad as the price it is executed at. If the company buys shares below the true value of the company then they are fantastic. Fewer shares in issue is a good thing for improving earnings per share in future.

If the company buys shares at an inflated value then they are a waste. Overpaying for something usually is.

The thing is, management are often in a great position to value the company. Management get lauded and rewarded for improved EPS. They have the industry knowledge and understand far better than most where the company sits against competitors. No manager truly wants to waste money on doing anything that will impair EPS. So a buyback might be taken as one indicator that the company may be undervalued.

And an extra buyer in the market is a positive for shareholders generally, adding liquidity. Buybacks are often more favourable than dividends in terms of tax treatment, as their benefit (if one exists) accrues only on disposal and thus is treated as capital gain at a time of your choosing rather than taxed as income.

We must also consider cost of capital: if a company is paying a 10% dividend on shareholder equity, but can borrow at 5%, it might make sense to take on extra debt to buyback shares, as the overall cost of capital is lowered. In the converse situation the wiser action might be to pay down debt.

The side effect of this is to change the debt ratios of the company, an altered debt/equity split and that will affect the market perception of the bankruptcy default risk of the firm. In general, a lower cost of capital is good news. In this way the company is able to optimise its debt/equity split to reduce its cost of capital, lower its bankruptcy risk and improve overall returns.

So are buybacks a good thing? The answer: it depends.
But HYPers carping about share buybacks ought to consider that in an era of ultra-low-cost bank finance, their expensive dividends can look unwise on a cost of capital basis. They should expect more buybacks in future. Why yield extra shareholders 10% when you might raise debt to buy em out cheaper, and make the company more profitable by doing so.

So, in short, readers should know that the anti-buyback crowd on LemonFool are misguided and exhibit a certain myopia about dividend income. They seem blind to the risk to their investments posed by suboptimal corporate structures with high cost of capital. Getting the optimum corporate structure to lower cost of capital is unequivocally a good thing, and if buybacks are used as a means to do so then they are to be welcomed.

Prof Damodaran on buybacks in this classic article: https://aswathdamodaran.blogspot.com/20 ... e.html?m=1

Cost of capital: https://en.m.wikipedia.org/wiki/Cost_of_capital

[Itsallaguess]

Fewer shares in issue is a good thing for improving earnings per share in future.

Isn't it also a potentially good thing because there's then fewer shares to pay out future dividends on too?

Even with the above said though, when it comes to dividends and share buy-backs, isn't it the case that a middle-ground might often be sought where all interested parties can continue to feel involved in a potentially growing enterprise?

Flat or lowering dividends at the expense of buy-backs obviously won't be greeted with any sort of fan-fair by those reliant on dividends for their income, but surely this is all about finding a position where shareholders and those running such companies can both feel suitably rewarded by doing so?

Also, buy-backs at a price that looks over-inflated in future, where the market then marks down share-prices to a level below where previous buy-backs have been made will clearly raise questions regarding the suitability of performing buy-backs at those previous prices, or at those previous times.

Companies that perform buy-backs that can show a record of good judgement regarding when to do so might be a bit harder to find than you might think....

So I honestly don't think it's a simple case of saying that 'share buybacks are a beautiful thing', but then placing such a huge caveat on that statement by also saying 'they are great' when they are bought back at a price that undervalues the company, but 'they are a waste' if such a process is carried out at an 'inflated price'.

No-one would disagree with such caveats, of course, but surely the existence of such important caveats means that it's not that easy then to simply say that 'share buybacks are a beautiful thing', as you've done in the title of this thread?

Cheers,

Itsallaguess

[TUK020]

Companies that perform buy-backs that can show a record of good judgement regarding when to do so might be a bit harder to find than you might think....

IAAG,
are you able to give examples of companies with a good track record of buy back judgement, and others with a not so good record?
tuk020

[Alaric]

Shareholder returns are a combination of dividends and share price appreciation.

They are also a combination of dividends and share price depreciation. What about Companies that return capital by paying it back out of retained earnings by enhancing or maintaining dividends above the level of those earned from profits? The market suspects there are number of these around as indicated by shares with a high yield on current dividend an share price, but where the share prices has fallen and the dividend hasn't.

[AsleepInYorkshire]

All too often we see on these boards grumpy Fools whinging that a share buyback is taking place. The petulant mutterings usually go something like this: “Buybacks are reducing my dividend.... They used to be illegal...management want their share options to trigger”

They are, of course, entitled to their opinion.

No matter how wrong they are.

I'd like to compliment you on getting your summation out at the start of the post. I shall wear my badge with pride. A grumpy old whinging petulant, opinionated and wrong fool

AiY

[Itsallaguess]

Companies that perform buy-backs that can show a record of good judgement regarding when to do so might be a bit harder to find than you might think....

are you able to give examples of companies with a good track record of buy back judgement, and others with a not so good record?

Unfortunately not, although my collective anecdotal evidence suggests that we shouldn't ever automatically assume that when we see a company buying back it's shares, that it has a good handle on the appropriateness of doing so from a purely 'valuation' sensibility...

Cheers,

Itsallaguess

[JoyofBrex8889]

Next is one frequently cited as being canny at buying back its own shares.

Discount control mechanisms in investment trusts are another example of a value enhancing buyback.

Buybacks of VCT shares illustrate the liquidity argument nicely, buyers are hard to find so the company acts to help would be sellers.

[Itsallaguess]

Next is one frequently cited as being canny at buying back its own shares.

Discount control mechanisms in investment trusts are another example of a value enhancing buyback.

Buybacks of VCT shares illustrate the liquidity argument nicely, buyers are hard to find so the company acts to help would be sellers.

I don't think anyone would suggest that the process of buying back shares isn't sometimes the right thing to do, or that some companies such as the ones you cite might have example of when they were 'right' to do so.

The problem is that your opening post seems to suggest that it's always a 'beautiful thing' when it does occur, and that anyone suggesting that sometimes it might not be an appropriate use of company funds is 'petulant' and 'wrong'....

Things aren't ever that black and white, so to see someone taking such a strong stance on this comes as a bit of a surprise...

Cheers,

Itsallaguess

[Dod101]

I suspect that JoyofBrexit is being deliberately controversial, because after the somewhat misleading heading he goes on rightly to qualify what he actually means. Sometimes they are a good thing; sometimes not. Currently we have a very large buyback in progress with Royal Dutch Shell and a smaller one with HSBC. There are probably others. Both of those seem sensible. To the positives can be added a) fewer mouths to feed from the dividend and b) a modest increase in the share of the enterprise owned by the continuing shareholder.

The effect can best be seen with ITs where they publish NAV per share, often on a daily basis, so it is easy to see where the buyback is being undertaken at below NAV and it is simple arithmetic to see that that benefits the continuing shareholder. It is much more difficult to see this with a large and complicated enterprise like either of the two companies I have mentioned above. On the whole though, I am not against buybacks.

Dod

[simoan]

Whilst I have nothing to add to this thread, I will just refer to what I consider to be the bible on share buybacks. IMHO Everyone that invests in shares of companies (especially those regularly doing buybacks) should read this PDF by Terry Smith and team...

https://www.fundsmith.co.uk/docs/defaul ... ?sfvrsn=18

All the best, Si

[XFool]

Things aren't ever that black and white, so to see someone taking such a strong stance on this comes as a bit of a surprise...

Depends on who is taking the stance, surely?

[BusyBumbleBee]

I am sadly disillusioned this morning - I had always thought "Joy of Brexit" was a modern Boudica (who was of course)

the queen of the British Celtic Iceni tribe who led an uprising against the occupying forces of the Roman Empire

where the modern version is

a champion of the British tribe leading an uprising against the occupying forces of the European Empire

Dod101 has spoilt that dream by pointing out that JoyOfBrexit is a 'he'

More seriously - is this an investment strategy? Or even a strategy in the making?

ITs often buy back shares - into treasury - as a price/discount to NAV stabilizer - which I don't like cos I like to play the discounts

VCTs really do buy back shares - in fact they are often the only buyer - again I don't like it cos it stops me buying at a big discount to NAV - and that was one of my investment strategies. Now I am waiting until tragedy strikes and the VCTs run out of cash for buybacks and the SP becomes really distressed leading to purchases giving a good tax free yield..

[EssDeeAitch]

All too often we see on these boards grumpy Fools whinging that a share buyback is taking place. The petulant mutterings usually go something like this: “Buybacks are reducing my dividend.... They used to be illegal...management want their share options to trigger”

They are, of course, entitled to their opinion.

No matter how wrong they are.

I'd like to compliment you on getting your summation out at the start of the post. I shall wear my badge with pride. A grumpy old whinging petulant, opinionated and wrong fool

AiY

Wrong? One thing I have learned on this forum, from HYP, to Brexit and now share buy backs is that there is no wrong or right, only opinion with all the flaws, biases and half knowledge that is part of the condition of being human.
So, your not wrong and niether is TJOB (but thats only my opinion, not what I know )

[vrdiver]

All too often we see on these boards grumpy Fools whinging that a share buyback is taking place. The petulant mutterings usually go something like this: “Buybacks are reducing my dividend.... They used to be illegal...management want their share options to trigger”

OK. Ignoring the pejorative tone for a moment, let's get down to facts.

As you've raised the issue, please provide a list of such complaints with the associated details of the share buy back (price, date) and current price.

VRD

[JoyofBrex8889]

I am sadly disillusioned this morning - I had always thought "Joy of Brexit" was a modern Boudica (who was of course)

the queen of the British Celtic Iceni tribe who led an uprising against the occupying forces of the Roman Empire

where the modern version is

a champion of the British tribe leading an uprising against the occupying forces of the European Empire

Dod101 has spoilt that dream by pointing out that JoyOfBrexit is a 'he'
..

This is quite the compliment. Thanks!

Anyway, we are constantly told by millennials gender is irrelevant. Or just a number. Something something gender blind.

I don’t think they would even know who Boudicca was, to be honest. Modern education is sorely deficient on actual education, preferring indoctrination in grey Maoist drivel rather than bringing the world to life through history.

Those educated today will probably never encounter William Blake, or Richard Coeur-de-Leon, or William Marshall or Sir Stamford Raffles or Captain Flinders or any of a myriad fascinating characters and adventurers from British history. No one can read of Mad Jack Churchill without a certain fascination, yet no milllenial will ever hear his name once in the course of a dull decade of schooling. Lord Cochrane reshaped a whole continent, yet he is not worthy of a moment of consideration in today’s schools. Yet we can learn so much from their example: good, bad, and simply interesting. Lord Cochrane teaches us the importance of timely information in the Stock Exchange. Mad Jack teaches us that you can be fearless in the face of just about any mortal danger. Captain Flinders teaches us accommodation with our enemies, and why trigonometry is important. Robert Corbet teaches us that the chief threats are probably on your own side, and the perils of zealous petty control.

Anyway, thanks again. Kids these days don’t even know enough to get off my damn lawn.

[XFool]

Those educated today will probably never encounter William Blake, or Richard Coeur-de-Leon, or William Marshall or Sir Stamford Raffles or Captain Flinders or any of a myriad fascinating characters and adventurers from British history. No one can read of Mad Jack Churchill without a certain fascination, yet no milllenial will ever hear his name once in the course of a dull decade of schooling. Lord Cochrane reshaped a whole continent, yet he is not worthy of a moment of consideration in today’s schools. Yet we can learn so much from their example: good, bad, and simply interesting. Lord Cochrane teaches us the importance of timely information in the Stock Exchange. Mad Jack teaches us that you can be fearless in the face of just about any mortal danger. Captain Flinders teaches us accommodation with our enemies, and why trigonometry is important. Robert Corbet teaches us that the chief threats are probably on your own side, and the perils of zealous petty control.

Anyway, thanks again. Kids these days don’t even know enough to get off my damn lawn.

"Mad Jack" Churchill - "Any officer who goes into action without his sword is improperly dressed." - would undoubtedly shift them. A couple of blasts on his bagpipes would likely do the job.

[vrdiver]

Whilst I have nothing to add to this thread, I will just refer to what I consider to be the bible on share buybacks. IMHO Everyone that invests in shares of companies (especially those regularly doing buybacks) should read this PDF by Terry Smith and team...

https://www.fundsmith.co.uk/docs/defaul ... ?sfvrsn=18

All the best, Si

For those who don't want to read the whole thing (which is well worth reading, by the way!)

Summary

Most share buybacks now destroy value for remaining shareholders

[AsleepInYorkshire]

All too often we see on these boards grumpy Fools whinging that a share buyback is taking place. The petulant mutterings usually go something like this: “Buybacks are reducing my dividend.... They used to be illegal...management want their share options to trigger”

They are, of course, entitled to their opinion.

No matter how wrong they are.

Shareholder returns are a combination of dividends and share price appreciation.

Now it is true that diverting cash from a dividend to a buyback is going to reduce income initially. However a share buyback is as good or as bad as the price it is executed at. If the company buys shares below the true value of the company then they are fantastic. Fewer shares in issue is a good thing for improving earnings per share in future.

If the company buys shares at an inflated value then they are a waste. Overpaying for something usually is.

The thing is, management are often in a great position to value the company. Management get lauded and rewarded for improved EPS. They have the industry knowledge and understand far better than most where the company sits against competitors. No manager truly wants to waste money on doing anything that will impair EPS. So a buyback might be taken as one indicator that the company may be undervalued.

And an extra buyer in the market is a positive for shareholders generally, adding liquidity. Buybacks are often more favourable than dividends in terms of tax treatment, as their benefit (if one exists) accrues only on disposal and thus is treated as capital gain at a time of your choosing rather than taxed as income.

We must also consider cost of capital: if a company is paying a 10% dividend on shareholder equity, but can borrow at 5%, it might make sense to take on extra debt to buyback shares, as the overall cost of capital is lowered. In the converse situation the wiser action might be to pay down debt.

The side effect of this is to change the debt ratios of the company, an altered debt/equity split and that will affect the market perception of the bankruptcy default risk of the firm. In general, a lower cost of capital is good news. In this way the company is able to optimise its debt/equity split to reduce its cost of capital, lower its bankruptcy risk and improve overall returns.

So are buybacks a good thing? The answer: it depends.
But HYPers carping about share buybacks ought to consider that in an era of ultra-low-cost bank finance, their expensive dividends can look unwise on a cost of capital basis. They should expect more buybacks in future. Why yield extra shareholders 10% when you might raise debt to buy em out cheaper, and make the company more profitable by doing so.

So, in short, readers should know that the anti-buyback crowd on LemonFool are misguided and exhibit a certain myopia about dividend income. They seem blind to the risk to their investments posed by suboptimal corporate structures with high cost of capital. Getting the optimum corporate structure to lower cost of capital is unequivocally a good thing, and if buybacks are used as a means to do so then they are to be welcomed.

Prof Damodaran on buybacks in this classic article: https://aswathdamodaran.blogspot.com/20 ... e.html?m=1

Cost of capital: https://en.m.wikipedia.org/wiki/Cost_of_capital

Hmm ... about a year ago I learned a valuable lesson. I was working with a new Site Manager. Every time I called at site I found he was moaning. He never stopped. And I noticed he moaned and groaned to everyone constantly. So much so that any genuine concerns he had were just lost in the cacophony. It wasn't frustration. It wasn't concern. He moaned because he simply knew nothing better. And he had become bloody good at it. Clearly over the years he had honed his skills. One particular day he launched a deluge of complaints upon my sensitive ears before I had crossed the threshold into the site cabin. There were no greetings, no small talk, nothing but a complete tirade of Anglo-Saxon verbs. This guy could make Eeeyore look optimistic.

It was at that moment that a very small penny dropped for me. I mused that there were two kinds of people in the world. Those with their glass half full and those with their glass half empty. Yet in front of me stood a third. Someone with no glass at all. For the most my glass is half full. From time to time as life drapes it grime stained stench in my direction I find myself staring at a glass that's half empty. I slump into a pit of despair and often find comfort in self pity.

For the most I view share backs as a short term mechanism of no real intrinsic value to the long term benefit of a business. However, if the price the company pays for their own stock results in significant margin growth in the long term there is indeed an effective argument - a glass half full, half empty debate. Yet there's the third, albeit rare case of no glass at all. I'd suggest that most share buy-backs are perceived by the Board as being a glass half full opportunity when in reality the glass they think they are looking at just isn't there. It's not even a case of them mistakenly looking at a glass that's half empty and getting some of the facts slightly wrong. They walk down the path of self indulgence and convince themselves that the glass is indeed there and it is half full. It's an extremely dangerous value trap.

The opening poster correctly stated we are all allowed our opinions. For as much as mine is wrong I am not going to change my errant ways and view share buy backs positively. On this subject I am going to have no glass at all

But I am not a Warren Buffett. So let's hear from him shall we.

http://berkshirehathaway.com/letters/2016ltr.pdf
Share Repurchases (Page 7)
In the investment world, discussions about share repurchases often become heated. But I’d suggest that participants in this debate take a deep breath: Assessing the desirability of repurchases isn’t that complicated.

AiY

[jonesa1]

I worked for many years for a US IT company that has spent a fortune over more than 20 years buying its own shares, at the same time as cutting costs to an extent that crippled any ability to deliver quality services. During this period the share price performance has been woeful, the revenue has progressively declined, profitability has reduced, but the senior execs all trousered great performance bonuses because EPS targets have usually been met. At some point the death spiral will destroy all remaining share-holder value, but a small number of execs will have become very rich indeed. It could be that for some companies share buy-backs make sense, for my previous employer, a business that generates a huge amount of cash, if share-holder value was indeed the motivation (as always stated, cynically some might think), then surely a capable management team could think of more useful things to do with the cash?

Andrew

[Arborbridge]

I am sadly disillusioned this morning - I had always thought "Joy of Brexit" was a modern Boudica (who was of course)

the queen of the British Celtic Iceni tribe who led an uprising against the occupying forces of the Roman Empire

where the modern version is

a champion of the British tribe leading an uprising against the occupying forces of the European Empire

Dod101 has spoilt that dream by pointing out that JoyOfBrexit is a 'he'

More seriously - is this an investment strategy? Or even a strategy in the making?

ITs often buy back shares - into treasury - as a price/discount to NAV stabilizer - which I don't like cos I like to play the discounts

VCTs really do buy back shares - in fact they are often the only buyer - again I don't like it cos it stops me buying at a big discount to NAV - and that was one of my investment strategies. Now I am waiting until tragedy strikes and the VCTs run out of cash for buybacks and the SP becomes really distressed leading to purchases giving a good tax free yield..

We should remember that Boudicca was ultimately a loser - a glorious failure. It seems somehow apt in the present circumstances to remember her.

As regards buybacks: I don't much like them, If there's cash to splash, let me decide whether I want to reinvest it in the same of a different company.
Arb.