Shareholders often see short-term gains from share buybacks, but there is a growing chorus of disapproval of them
by Brian Gorman
When companies have excess cash and can’t see a better investment opportunity, they often decide to buy their own shares, giving investors a boost.
The economics are simple enough. The supply of shares goes down, and assuming demand remains the same, the price will go up.
Buybacks hit record
An article on CFO Dive by Jim Tyson points to a forecast by Goldman Sachs that US company buybacks will reach US$1tn this year. This will top the 2021 record of US$992bn.
The article quotes Neil Kearns, head of corporate trading at Goldman Sachs, who says that earnings have held up well and companies have excess cash on balance sheets. “Absent alternative uses of that cash, investors are going to continue to demand that it is returned to them,” he said.
But opposition to buybacks is growing. “Buybacks have drawn fire from lawmakers who say the strategy enriches shareholders and executives while failing to improve the quality of businesses or their goods and services,” says Tyson. As a provision of the Inflation Reduction Act, publicly traded companies will, from 2023, have to “pay a 1% excise tax on stock buybacks totalling more than US$1m in a tax year,” he writes.
Energy firms fuel controversy
Centrica, owner of British Gas, saw its shares rise more than 7% on 10 November, the day it announced a share buyback, according to London Stock Exchange data. An article in CityA.M. by Nicholas Earl and Michiel Willems says that the surge in energy prices will help the company achieve a net profit six times that of the previous year, and that it plans to spend some £250m repurchasing up to 5% of its shares over the next three to four months.
The shares continued to rise in the days following the announcement and hit a three-year high.
Companies announcing buybacks are often highly profitable and their shares might have risen, to some extent, without a buyback. But Centrica is an example of a trend and it is widely acknowledged that, in the short term, at least, buybacks boost share prices. Doubts persist about the longer-term effects.
What is the long-term effect?
The “buyback wave” has been criticised for undermining economic growth, “leading firms to skimp on long-term investment to pursue short-term objectives such as earnings per share,” according to a 2018 paper by Alberto Manconi, Urs Peyer and Theo Vermaelen.
The concern is that companies are propping up their stock price in the short term at the expense of long-term shareholder value. However, the authors conclude from their study, which also takes into account other studies: “We can reject the hypothesis that, at least on average, share buybacks are bad for shareholder value.” That is, if markets are efficient.
However, in the past year or so, some political considerations have intensified, especially for energy companies. Firms making huge profits and announcing buybacks have led some politicians to call windfall taxes, with the money used to subsidise soaring household energy bills.
Earl and Willems say: “Centrica faces a difficult balancing act as it looks to reward shareholders who have backed the company through pandemic headwinds, with proceeds from bumper trading this year amid sustained criticism energy producers are cashing in on soaring oil and gas prices fuelled by Russia’s invasion of Ukraine.”
The argument could also be applied to any form of shareholder reward, such as dividends, but buybacks are coming in for special attention. The Progressive Policy Think Tank said in October 2022 that BP invested ten times as much buying its own shares as it reportedly invested in renewables in the first half of 2022. For Shell, the multiple was seven.
Tesla drives buyback
A buyback might be driven by a company and its shareholders feeling the market is undervaluing the shares.
Electric carmaker Tesla is a case in point. The shares have lost more than half of their value in 2022. An article in Markets Insider by Brian Evans says that this is “amid aggressive rate hikes from the Federal Reserve and Musk's Twitter acquisition”.
Tesla chief executive Elon Musk said in the company's third-quarter earnings call that Tesla was working on "the right process to do a buyback" in the US$5–10bn range.
Evans said the statement coincided with Musk’s prediction for the company's valuation. Musk has said Tesla could be worth “more than Apple and Saudi Aramco combined”, implying a market value of US$4tn. This compares with the current stock market valuation of about US$590bn.