Share buybacks have never been a more popular way for big companies to return money to investors. New research published by the asset manager Janus Henderson shows that the largest 1200 stock market-listed companies are spending 300% more on their own equity than they did a decade ago. Dividends have risen by just 54% over the same period.
Source: Janus Henderson/MarketWatch
But not all investors are happy, arguing that share buybacks are better for executive bonuses than they are for shareholders. Why are management and boards of the biggest public companies more frequently choosing to support their share prices through buybacks ahead of cash pay outs in the form of dividends? And are we as investors losing out as a result?
The Janus Henderson research is quoted by several media including the Financial Times as saying that the biggest 1200 listed companies spent $1.3 trillion buying back their own equity last year. That total was almost as high as the amount paid out in dividends.
The value of buybacks last year was also far from an anomaly with the trend building for some time and being maintained into this year. New multibillion-dollar buyback programmes have been announced by a host of companies in 2023, including Wall Street tech giants Apple and Airbnb and London-listed FTSE 100 constituents HSBC and the catering company Compass.
Energy, particularly oil and gas companies, was last year’s best performing sector with record profits raked in on the back on elevated fuel commodity prices. Oil and gas prices have been driven up by sanctions imposed on Russia, one of the world’s largest exporters, and coordinated production cuts by the Opec+ group of oil-producing nations.
Source: Energy Monitor
That’s seen revenues boom for big oil and gas, which saw profits double to $200 billion, and companies responded by using a vast swathe of the bounty to repurchase $135 billion worth of their own stock last year. That’s four times the amount spent the previous year and while dividends were also hiked, it was by nowhere near as much. BP’s 10% dividend increase sounds healthy enough but much less so when compared to the simultaneously announced $2.75 billion of fresh share buybacks, taking the total for the year to almost $10 billion.
Source: Janus Henderson/MarketWatch
The rise in the use of buybacks ahead of dividends as a way to return cash to shareholders doesn’t seem to have been impacted by a new 1% tax on buybacks in the USA that came into effect on January 1st.
President Biden has since commented he would like to quadruple that tax and the SEC recently approved a rule a rule that will oblige listed companies to reveal more details on buybacks, such as the number of shares purchased and average price paid.
What are share buybacks and how do they benefit investors?
When a company has accumulated more cash than its board and investors consider it necessary to keep as a rainy day fund, it has a number of options designed to increase investor returns.
It can invest the cash in growing the company, either internally or through acquisitions. Growth companies spend most of their spare cash flow in this way.
Alternatively, it can return excess cash to investors in one of two ways. The first is in the form of dividends, cash payments per share made to their owners. It is dividends that are referred to when a stock is said to provide an ‘income’.
The second way to return cash to shareholders is the less direct route of a share buyback programme. A share buyback is exactly what it sounds like – a company uses cash to purchase its own shares on the free market.
Once bought back by the company, these shares are cancelled, which decreases the total issued equity. That correspondingly boosts the equity represented by remaining shares, theoretically boosting their value. It also increases earnings per share, an important measure of company profitability, and means each remaining share will command a higher percentage of future dividends paid.
What are the criticisms of the investor value of share buybacks vs dividends?
Critics of share buybacks, or at least of buybacks beyond a certain level, point to the contingent nature of the shareholder benefit that results, compared to the certainty of a dividend payment.
When a company announces a dividend, shareholders know exactly what it represents as a return on their investment as it is a fixed cash sum. And if they sell their shares the day after the dividend has been paid out, it is theirs to keep.
Share buybacks, meanwhile, rely on the market to adjust its valuation of individual shares in line with the increased equity in the company they now represent. But buying back 1% of issued shares doesn’t just neatly result in that being reflected in a 1% rise in the value of the remaining shares.
Markets are imperfect and if the general sentiment is positive, market capitalisation gains could be greater than the corresponding buyback. But if it turns negative or is even indifferent, the share price may not reflect buybacks at all, or not to the corresponding extent. If the market doesn’t react to a buyback, investors not only haven’t seen any return on investment but the company has spent a chunk of its cash for nothing.
The evidence suggests investors are justified in their scepticism of buybacks vs dividends as a mechanism of returning excess cash to them. An Invesco fund that tracks the price of companies that do large buybacks has underperformed the US market over the past decade.
Few would deny that buybacks are a valid and useful mechanism companies should make use of to keep house and reinforce shareholder value. But many shareholders would prefer that capital be spent on buybacks more conservatively and more free cash-flow returned as a guaranteed return on investment in the form of dividends.
Quoted by the Financial Times, Abrie Pretorius, a manager at U.S. investment manager Ninety One, comments on what he sees as the appropriate conditions for buybacks with:
“Buybacks only create value for remaining shareholders and strong relative performance when shares are cheap and there are no better uses of that cash which would generate higher returns. Most buybacks help optical [earnings per share] growth but destroy value.”
There are suspicions that the recent trend towards diverting more cash away from dividends and towards buybacks may be at least partly incentivised by executive self-interest.
Euan Munro, chief executive of Newton Asset Management says his company would prefer less buybacks than is currently the case, concerned that they often target improvement of the kind of medium term metrics executive bonuses are often linked to at the expense of creating longer term shareholder value.
Which companies are keenest on buybacks?
As a general rule, it is Wall Street-listed companies that have most enthusiastically embraced the trend of more share buybacks ahead of dividend hikes in recent years.
Between 2012-2022, large cap American companies increased buybacks from $333 billion to $932 billion. European companies only doubled their rate of buybacks over the same period, to a total $148 billion. London-listed companies more than tripled the value of their buybacks over that decade to $70 billion, suggesting the trend is catching on.
The advantages of buybacks over dividends
While their recent level has drawn criticism in some quarters some investors are happy with the trend towards more free capital being invested in buybacks. Their arguments include that if the purchase price of buybacks is attractive it can be a very effective way to create l value for long term investors.
Markets also tend to punish companies that increase dividends unsustainably, returning lots of cash to investors one year and then being forced to reduce the payout in future. And any enhanced value created by buybacks doesn’t come with a tax bill in the same way as dividends do. Shareholders can control when tax is due by selling or not selling shareholdings.
Shareholders must tell boards what they want
Ultimately, shareholders have to tell boards if they feel too much excess cash is being spent on buybacks compared to dividends. And if they don’t want to listen at first, hope the market makes them.
That’s the big picture view. On an individual level, it is good to be aware of the trend. And if income is a priority for you, at least if it comes down to a choice between it and the value lottery of buybacks, you might consider reallocating more capital to companies that prioritise dividends.