In recent weeks there has been a flurry of big companies announcing share buyback programmes.
Just this week Holiday Inn owner IHG announced a fresh $800million (£633 million) buyback scheme. Other household names have launched similar programmes in past months.
It is part of a longer-term trend in which corporates are shunning dividends in favour of buybacks to return capital to shareholders. Some estimates suggest around half of companies on the main market have bought back shares.
While this might have become a popular option for big companies, it is not so well understood by investors.
We look at why so many are buying back their shares and what it means for both the UK market and investors.
Buyback bonanza: Estimates suggest half of UK companies on main markets have bought back their shares
What are share buybacks?
Share buybacks are another way for firms to return excess to shareholders by buying their own shares, cancelling them and ultimately reducing the number of shares in circulation.
One of the main reasons a company buys back shares is because they believe that their stock is undervalued. Cutting the number of issued shares can help to push up the value of the remaining shares.
In practical terms, companies often favour buybacks over dividend payouts because they’re more flexible. Companies can’t really start to increase a dividend without being fairly certain they can continue to pay out to shareholders.
Opting for a buyback when there’s excess cash means that when tougher times come, they can be halted and firms are less likely to face criticism than if a dividend is cut.
Buybacks are also often favoured because they can be more tax efficient as the capital gains can be taxed at a lower rate than income from dividends.
But buybacks also trigger a lot of debate. Critics say that if a company’s share price rises after the announcement of a buyback, short-term investors can make a profit.
They also say that cutting the amount of shares in circulation make it easier to earn bonuses tied to earnings per share.
Why are more UK companies opting for share buybacks now?
Share buybacks have been a major feature of the US market, especially in tech companies, while dividends have been more of a priority in the UK.
This month Uber announced a $7billion share buyback after reporting its first full-year operating profit.
But research shows that, for a second year running, large UK companies almost matched the US when it came to buybacks.
It marks a huge departure from previous activity where US activity has outstripped any other major market.
Last year the proportion of UK companies doing larger buybacks beat the US – 13 per cent of UK companies bought back at least 5 per cent of their shares compared with 9 per cent in the US.
So why have buybacks become so popular in recent years?
Share buybacks have been a major feature of the US market with Uber announcing a $7billion one this month
UK companies trade at a huge discount, around 10.8 times their forecast earnings for 2024, well below the long-term median level of over 13 times.
Investors neglecting UK equities means that companies are looking to buybacks
Jason Hollands, managing director of Bestinvest, says: ‘With UK share prices so undervalued, the case for companies who have cash on their balance sheets to use some of this to buy their own shares and then cancel them to reduce the shares in issuance, is a quite compelling form of self-help rather than just waiting things out and hoping investors will at some point take interest in the UK again.’
Investor interest in the UK is waning amid economic uncertainty and is doing little to change the ‘unloved and undervalued’ moniker the UK has reluctantly adopted.
‘If companies don’t act to support their share prices, international predators could soon turn up and seize a bargain for themselves by acquiring UK companies,’ adds Hollands.
Ian Lance and Nick Purves of Redwheel, who manage the Temple Bar investment trust, have taken this view. They point to Next which managed to deliver a total return of 15.4 per cent per annum between 2001 and 2021, when sales grew just 4.6 per cent a year, in large part because of a share buyback programme that cut shares in issue by 60 per cent.
At the end of last year, Lance said buybacks would rerate depressed valuations across UK equities.
Others are more cautious about buybacks, preferring instead to invest surplus cash back into the company.
Brendan Gulston, co-manager of the WS Gresham House UK Multi Cap Fund, says: ‘This aligns better with their core skill set rather than determining stock level valuations and optimal times to buy back their own shares.’
What do more buybacks mean for the UK market?
In the short-term, increased buybacks will put more cash in shareholders’ pockets and go some way in galvanising the market again.
Darius McDermott, managing director at FundCalibre, says: ‘In the past one of the weaknesses of the UK market is that it has over distributed its cash flows to income hungry investors.
‘One of the consequences of the pandemic is that it gave a lot of companies the cover to rebase their dividends to a more sensible level. This has left them with more cash to reinvest allowing them more flexibility to do things like share buybacks.’
Share buybacks can be an attractive use of capital, particularly when valuations reach acute levels of dislocation
But it doesn’t come without its issues. Hollands says: ‘While buybacks can most definitely help boost shareholder returns and could be just the catalyst that the UK market needs to reignite investor interest, they are not without their critics.
‘When companies themselves become the largest buyers of their own shares, some would argue shareholder cash would be better returned to them in the form of higher dividends, so they can decide where to invest it.’
While there has been criticism of the market losing out on IPOs and more companies delisting, Schroders strategist Harry Goodacre suggests buybacks also remove equity from markets.
An analysis of net buybacks and new entrants/delistings finds that in the 12 months to December 2023, net equity supply was negative in the US, UK, Japan, France and Germany.
‘While much focus has been on the declining number of listed companies, we shouldn’t forget the contribution of share buybacks to the trend of de-equitisation,’ says Goodacre.
‘For a second year running, use of share buybacks outside the US has been much more common than in the past, and that’s despite a higher interest rate environment.’
Given just how undervalued UK equities have become though, share buybacks might seem the only option for some companies.
Gulston says: ‘In certain circumstances share buybacks can be an attractive use of capital, particularly when valuations reach acute levels of dislocation from the fundamentals.’
Hollands adds: ‘When UK shares are cheap, dividend yields are attractive, I’m in favour of companies buying back their shares to boost shareholder returns. It could be just what the UK market needs.’
What do buybacks mean for investors?
Generally investors tend to like share buybacks because they’re receiving some of the excess cash from the company where they’re shareholders.
Investors tend to assume that the buyback will reduce the share count and push up the value of the company per share, but how much does it boost the long-term value?
‘An increase in buybacks may also signal an absence of profitable investment opportunities for the company concerned,’ says Goodacre. ‘So, rather than a positive, they could be interpreted by investors as a negative.’
But McDermott thinks buybacks are misunderstood by some investors and ‘there is a misperception that somehow [they’re] a bad thing because companies should be investing instead. This is completely wrong… share buybacks are very simple.’
For investors, they are a more tax efficient way to receive surplus capital because, unlike dividends, they are taxed at nothing or at a much lower rate.
McDermott says: ‘This is why Warren Buffet will conduct share buybacks for Berkshire Hathaway if the shares get too cheap, but it has never paid a dividend. When done well a buyback can add tremendous value to shareholders.
‘Equally if a company is in trouble and seeing its business collapse it is a common mistake for management teams to try and sure up sentiment with a share buyback, which can have the consequence of throwing good money after bad.
‘The bottom line is it’s situation dependent but buybacks can be very effective and investors should not be irrationally and emotionally against them.’
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