Share buybacks. Good, Bad, or Ugly?

On By jpmeyer96In Investing, Markets

Publicly-traded companies buying their own shares (share “buybacks” or “repurchases”) increase earnings per share by reducing the total number of shares outstanding (identical earnings spread over fewer shares).  It’s commonly positioned as “returning value to shareholders,” because investors who maintain their shares end up owning a larger percentage of total company shares; in turn owning a larger percentage of future earnings.  As of February 10th, S&P 500 companies have announced plans for $99 billion dollars of share buybacks in 2016.   The largest start to the year ever.  Get ready to receive some serious value!

Not so fast – to understand the “value” of a share buyback, investors need to understand the why behind the buy.  There are four common reasons why companies repurchase shares:

  1. Employee bonuses paid with stock options dilute other investors’ ownership by increasing the total number of shares outstanding. Buying back shares prevents this, but despite maintaining the average investors’ ownership stake, employees receiving stock options are the ones who disproportionately win.
  2. Repurchasing shares allows companies to return cash to shareholders, while avoiding a sustained commitment via dividends. Dividends may need to be cut in lean years – a scenario that is almost always accompanied by a decline in stock price.
  3. Disreputable executives may redeem their stock options for shares, and sell them to the company at higher than market prices. That’s right, buybacks can happen at higher than current market prices – suspicious behavior indeed.
  4. Management determines shares are undervalued, is already investing for future growth, and uses the remaining cash to buy back shares and reward long-term investors (those not selling) with a higher percentage of those future returns.

That last reason sounds like an astute management team using earnings for future growth, and rewarding the loyalty of long term investors, right?  Funny you should say that, because at MCM, we think so too.  In fact, that’s just the sort of buyback we agree is actually good for investors.