BP’s announcement today that it plans to spend another £2.9bn on share buybacks has brought its total for the year to £6.1bn, with the figure standing at £17.3bn for the oil & gas sector.
Thirty-four members of the FTSE 100 have now announced or carried out share buybacks in 2022, for a total of £46.9bn. Along with rising dividend payouts – which are expected to reach £85bn this year – these buybacks have helped the UK index hold up in a year when most other major markets have fallen.
Source: AJ Bell
“Those planned cash returns may therefore be helping to persuade investors to stick with UK equities rather than look elsewhere,” said Russ Mould, investment director at AJ Bell.
But while buybacks push up share prices in the short term, they are not universally positive for long-term investors. The Securities Exchange Act of 1934 banned buybacks in the US, saying they could be regarded as a form of share price manipulation, and it was only repealed in 1982 by the Reagan administration.
“Since then, buybacks have become increasingly popular,” Mould added. “The UK has followed America’s lead to some degree here, although dividends are still the more common means for returning cash to investors.”
Below, he runs through the major advantages and disadvantages of share buybacks.
Four arguments in favour of buybacks
- 1. If a company is generating surplus cash, then it can return this money to shareholders and let them decide what to do with it, rather than spend it on an unnecessary acquisition or capacity increases. “This is a particularly acute issue at a time when interest rates remain low, even after some recent increases, and, as a result, firms are not gaining a substantial return on any cash holdings,” said Mould.
- 2. Buybacks can offer favourable tax advantages compared with dividends. For example, higher-rate taxpayers will have to pay tax of 39.35% on any dividends they receive after the first £2,000. With buybacks, they won’t have to pay any tax until they sell the investment, when it will be classed as a capital gain. In this case, the first £12,300 of profit will be free, and anything above this will be taxed at 20%.
- 3. Anyone who elects to retain their shares when a firm buys back stock will have an enhanced stake in the company and thus be entitled to a bigger share of future dividends (assuming there are any).
- 4. “Buybacks can also suggest that a management team feels a company’s shares are undervalued, so any move to buy stock can be seen as a vote of confidence in the firm’s near- and long-term trading prospects,” said Mould.
However, he added that there was also good reason to treat share buybacks with some degree of caution “and not blindly welcome them all as a good thing”.
Four arguments against buybacks
- 1. First, history shows companies have a habit of buying stock back during bull markets (when they tend to be more expensive) and not doing so during bear ones (when they tend to be much cheaper). For example, Mould said buybacks in the US topped out in 2007 and collapsed in 2008 and 2009, only to reach new highs in 2018 as stock prices reached new peaks. “A similar pattern can be seen in the UK, and the higher share prices have gone, the more buybacks there seem to have been in 2021 and 2022 on both sides of the Atlantic,” he added.
- 2. The tendency among some management teams to buy high rather than low could therefore throw into question whether they are sufficiently objective when taking this action to show the market they feel their stock is undervalued. For example, in an article published on Trustnet in April, Nick Shenton of the Artemis Income fund said the spike in buybacks this year was being driven by management teams who were desperate to keep their jobs: “Our guess would be that in boardrooms in the UK in the past year or so, they have looked at the amount of incoming deals from private equity and thought, ‘our share price is leaving us vulnerable’.”
- 3. A buyback could also be used to massage earnings per share figures by reducing the share count at a limited cost. This could be used to trigger management bonuses or stock options, courtesy of some near-term financial engineering. Shenton said that to account for this “scam”, which is more common in the US, he analyses free cashflows after share buybacks.
- 4. Finally, Mould said there was the risk that some firms buy back stock using debt, potentially weakening their balance sheet and competitive position in the long term. There is the same danger with dividends.
He added: “Any short-term financial engineering could therefore damage a firm’s long-term ability to invest in its customer proposition and defend its market share to the potential detriment of profits, cash flow, the ability to return cash and – ultimately – the share price.”