A recent article from Canada’s Globe and Mail ("Share Buybacks: The wrong way to reward shareholders") suggests that stock buybacks are - as a rule - useless.
The Globe article states that after a buyback program is announced a company's stock price usually declines anyway; that is, the buyback typically signifies a peak, and does not add any value to shareholders. But is this correct? How can buying back shares not add value to shareholders?
The Globe's simple look at the statistics ignores the rationale for doing buybacks. In fact, there are good stock buybacks and bad ones, and management’s reasoning makes all the difference.
Share buybacks can be the best way to reward shareholders. The fact that the market doesn't immediately recognize this and boost the stock price is irrelevant.
When a company's shares are trading at close to or below book value and at low P/Es, why would the company issue dividends or make acquisitions? Buying the stock of an underpriced company (their own) is the best choice. Every share bought back by the company means more earnings for remaining shareholders. For example, if a company has earnings per share of $.50 and you own 100 shares, your personal share of the earnings is $50.00. If the company buys back ¼ of its shares, your personal share of the same earnings is now $62.50. Eventually, more earnings per share = a higher stock price.
On the other hand, if a company's stock is overvalued either in terms of P/E or book value (or both), then share buybacks are clearly a waste of money: why buy back overpriced shares when the same money could be used to make valuable acquisitions or pay a dividend? In this case, a share buyback doesn't make sense.
When management does a share buyback for the right reasons, people notice. When Berkshire Hathaway, for example, announced in Sept of 2011 that it would buy back shares, BRK jumped 8% in a single day.
The Globe and Mail article notes that companies typically buy back stock when they are flush with cash but stock prices are high - which is the wrong time to buy back stock. At the moment, however, many companies are flush with cash at a time when their stock prices are low - the perfect time to buy back stock.
Good companies pay extra dividends or make acquisitions only when their stock is overvalued (or at least fairly valued). When their stock is undervalued, buybacks are the best choice.
The Globe article states that after a buyback program is announced a company's stock price usually declines anyway; that is, the buyback typically signifies a peak, and does not add any value to shareholders. But is this correct? How can buying back shares not add value to shareholders?
The Globe's simple look at the statistics ignores the rationale for doing buybacks. In fact, there are good stock buybacks and bad ones, and management’s reasoning makes all the difference.
Share buybacks can be the best way to reward shareholders. The fact that the market doesn't immediately recognize this and boost the stock price is irrelevant.
When a company's shares are trading at close to or below book value and at low P/Es, why would the company issue dividends or make acquisitions? Buying the stock of an underpriced company (their own) is the best choice. Every share bought back by the company means more earnings for remaining shareholders. For example, if a company has earnings per share of $.50 and you own 100 shares, your personal share of the earnings is $50.00. If the company buys back ¼ of its shares, your personal share of the same earnings is now $62.50. Eventually, more earnings per share = a higher stock price.
On the other hand, if a company's stock is overvalued either in terms of P/E or book value (or both), then share buybacks are clearly a waste of money: why buy back overpriced shares when the same money could be used to make valuable acquisitions or pay a dividend? In this case, a share buyback doesn't make sense.
When management does a share buyback for the right reasons, people notice. When Berkshire Hathaway, for example, announced in Sept of 2011 that it would buy back shares, BRK jumped 8% in a single day.
The Globe and Mail article notes that companies typically buy back stock when they are flush with cash but stock prices are high - which is the wrong time to buy back stock. At the moment, however, many companies are flush with cash at a time when their stock prices are low - the perfect time to buy back stock.
Good companies pay extra dividends or make acquisitions only when their stock is overvalued (or at least fairly valued). When their stock is undervalued, buybacks are the best choice.
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"When companies purchase their own stock [at a discount to fair value], they
often find it easy to get $2 of present value for $1."
Warren Buffett
Warren Buffett
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