What are share buybacks?

When a company repurchases some of its shares from shareholders, the process is known as a share buyback. Let's explore.

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When a company repurchases some of its shares from shareholders, the process is known as a share buyback. Once the buyback is complete, the company will cancel the repurchased shares, reducing the total number of outstanding shares on issue. 

In essence, a share buyback reduces the amount of a company's share capital. 

All things being equal, this should boost shareholder returns because the company's profits will be spread across fewer shares. For this reason, share prices often rise after a company announces a share buyback program.

Why conduct a share buyback?

The share buyback process is a form of capital management. Companies can use share buybacks to optimise their capital structure and allocate financial resources efficiently. 

When companies have excess capital, they must decide the most efficient way of using this capital. Undertaking a share buyback is one way to redistribute the excess to shareholders. And it's an alternative to paying a bigger dividend

A stock buyback results in fewer shares on issue, so it can increase earnings per share (EPS) and improve return on equity (ROE). This, in turn, can lower the company's price-to-earnings (P/E) ratio.  All things being equal, this may lift the stock price for the remaining shares trading on the market.

How does it work?

A share buyback can proceed in two ways – on-market by the company purchasing the shares on the ASX or off-market via a tender process conducted directly with shareholders. Investors can choose whether to participate in a buyback program. 

For an off-market buyback, shareholders can participate by following the directions provided by the company. For an on-market buyback, shareholders can simply sell their shares on the ASX. The buyer may or may not be the company itself. 

Dividend payout or share buyback: Which is better?

Both options are ways for companies to distribute cash to shareholders. While paying a dividend returns money to all shareholders, a share buyback returns cash only to those who choose to participate. 

Dividends and share buybacks can both help increase the overall return from shares, but there is debate over which is better for investors and companies in the long term. 

Dividends provide a straightforward return to all shareholders that can be particularly attractive to those seeking regular income, such as retirees. 

In contrast, a share buyback can be a more flexible option for returning capital, allowing a company to adjust its capital allocation based on current market conditions and investment opportunities.

Dividends provide shareholders with an instant return (and tax liability). A share buyback offers a return to shareholders who participate, upon which capital gains tax may be payable. 

By reducing the number of shares on issue, a share buyback should lead to an increase in the price of remaining shares over the long term. Investors will only realise any capital gain from the share price increase when they sell the shares. Of course, this also means that any tax payable on the increase in value is deferred until the shares are sold.

When would a company buy its shares back?

There are many reasons why companies choose to repurchase shares. It may be because management believes the shares are undervalued, to improve financial ratios, or to consolidate ownership. Share repurchases enable companies to distribute excess capital by following stock exchange regulations. 

Surplus equity reduction: Shareholders typically demand a return on their investment, so surplus equity capital can become burdensome. A company with limited growth opportunities may need more reason to deploy excess equity capital. In this scenario, repurchasing shares can effectively reduce the overall cost of capital. 

Valuation: Because they can help buoy share prices, share buybacks are popular with companies that consider their shares to be undervalued. 

Shares may be undervalued for many reasons, from short-term adverse impacts to general negative sentiment. When management believes its shares are undervalued, it may direct the company to invest in itself via a share buyback, thereby seeking to capitalise when market values normalise. 

Better metrics: Share buybacks improve financial metrics, so they can help enhance share price valuations. Additionally, it is less likely there will be an adverse share price reaction where a company chooses to reduce its level of share buybacks compared to cutting its dividend. 

Positive perception: Share buybacks can signal that a company is financially healthy, with management confident in reinvesting in itself. Generally viewed positively, share buyback announcements can lead to an influx of investors, thereby supporting the share price.

Which companies have conducted buybacks?

Many of the world's largest companies have undertaken share buybacks. Technology giants such as Apple and Alphabet conducted buybacks in 2023, with Apple buying back $77.55 billion in stock in fiscal 2023. Alphabet authorised $70 billion in share repurchases in 2023, matching the $70 billion in share repurchases announced in 2022. 

Warren Buffett's Berkshire Hathaway has long favoured share buybacks over dividends. The company hasn't paid a dividend since the 1960s. 

ASX shares have also seen buyback action, with Qantas Airways Limited (ASX: QAN) announcing an on-market buyback of $500 million in shares in August 2023, reflecting its strong profit recovery. The airline followed up with a $400 million buyback announced in February 2024. 

Cochlear Ltd (ASX: COH) began buying back shares in 2023 thanks to its balance sheet strength. Starting with a $75 million buyback, the company intends to buy back shares progressively over the coming years until its cash balance is approximately $200 million. 

Other ASX-listed shares that have conducted recent buybacks include AMP Limited (ASX: AMP), Temple & Webster Group Ltd (ASX: TPW), Kogan.com Ltd (ASX: KGN), and Estia Health Ltd (ASX: EHE). 

Are there any downsides to share buybacks?

The returns from share buybacks are far from guaranteed. If a company experiences difficulties after a share buyback, shareholders may not see the share price increase as anticipated. On the other hand, share buybacks can boost earnings per share, even for low-growth companies. This can result in higher valuations, pushing up the share price. 

Finally, if a company borrows money to repurchase its shares, a share buyback can impact its credit rating. Debt obligations can act as a drain on cash reserves if economic circumstances move against the company. Due to this, downgrades in credit ratings can follow debt-financed share buybacks. 

How to decide when to participate

When deciding whether to participate in a share buyback, investors should consider several key factors to ensure the decision aligns with their investment goals and financial situation.

First, evaluate the offer price and how this compares to the market price and your assessment of the intrinsic value of the company's shares. 

Secondly, review the tax implications of selling your shares back to the company, as these can vary significantly depending on your financial situation, impacting the net benefit of participating in the buyback. 

Thirdly, consider your perspective on the company's future performance. If you believe the company's shares are undervalued and have strong growth prospects, holding onto your shares could offer greater long-term gains than selling them back. 

Conversely, if you're sceptical about future performance or believe the market has fully valued the shares, participating in the buyback could be a prudent choice.

Additionally, understanding the company's reasons for the buyback can provide insights into its financial health and future strategy. For example, a buyback funded through debt might raise concerns about the company's leverage and financial stability.

In summary, investors should base the decision to participate in a share buyback on a comprehensive analysis of the offer's financial attractiveness, tax consequences, the company's future prospects, and how well the action aligns with personal investment strategy and goals.

Frequently Asked Questions

A share buyback, also known as a stock repurchase, is a financial strategy where a company purchases its own shares from the marketplace. The process involves the company reducing its available shares on the market, which in turn decreases the total number of outstanding shares.

Companies can execute share buybacks through two primary methods: on-market buybacks, where shares are bought on the stock exchange, and off-market buybacks, which involve purchasing shares directly from shareholders. This approach typically involves the company offering to buy back shares from existing shareholders at a specified price, which can be a premium to the market price. 

    Companies engage in share buybacks for many strategic reasons to enhance shareholder value. When a company has excess capital with no immediate high-return investment opportunities, it might choose to buy back shares. This can signal to the market that the company believes its stock is undervalued.  Reducing the number of shares outstanding can increase stock prices, benefiting shareholders.

    Share buybacks tend to improve financial ratios, such as earnings per share (EPS) and return on equity (ROE), making the company appear more financially attractive. Furthermore, buybacks offer a tax-efficient way to return money to shareholders, as capital gains are often taxed more favourably than dividends.

      Share buybacks can benefit both the company undertaking the buyback and its shareholders. However, the impacts can vary. For the company, buybacks can lead to an improved financial structure, enhanced stock valuations, and a signal of strong future prospects. Shareholders who retain their stock typically benefit from a potential increase in share value and a higher percentage of ownership in the company, which can lead to a larger share of future profits. 

      The benefits to shareholders can depend on the timing and execution of the buyback; if a company repurchases shares at a high price and the stock value decreases, the remaining investors may not see the anticipated gains. Conversely, shareholders who sell their shares during the buyback may benefit from immediate liquidity at a premium price. Ultimately, the effectiveness and benefit of share buybacks hinge on the company's strategic rationale and the execution of the repurchase program.

      This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

      To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

      As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

      Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Motley Fool contributor Katherine O'Brien has positions in Alphabet, Apple, and Cochlear. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet, Apple, Berkshire Hathaway, Cochlear, Kogan.com, and Temple & Webster Group. The Motley Fool Australia has recommended Alphabet, Apple, Berkshire Hathaway, Cochlear, Kogan.com, and Temple & Webster Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.