Some of the UK’s biggest companies have announced share buyback programmes over the past few months as the economy emerges from the worst of the pandemic.  

London-listed firms have launched share buybacks with a value of some £14billion so far this year, including 14 FTSE 100 firms, according to figures from AJ Bell.

It’s a significant turnaround from 2020, when share buybacks with a value of more than £10billion were scrapped as companies grappled with the effects of the pandemic. Just £1.6billion were approved and carried out from March to December.

‘Investors must now decide whether this [turnaround] is a sign that corporate confidence is flooding back, and the good times are about to roll once more; or whether boardrooms are letting down their guard too quickly in the wake of the pandemic and leaving their firms open to the next unexpected shock, whatever it might be,’ Russ Mould, investment director at AJ Bell says.

Natwest recently announced plans to buy back £750million worth of shares after returning to profit

Natwest recently announced plans to buy back £750million worth of shares after returning to profit

Natwest recently announced plans to buy back £750million worth of shares after returning to profit

What is a share buyback?

When companies build up a lot of excess cash they can either invest it in something, keep it for a rainy day or hand it back to shareholders.

If they opt to hand it back to investors, they can either hand it over as a dividend or by buying back the company’s shares from investors. 

Once the shares are repurchased they are considered cancelled but can be kept for redistribution in the future.

Why do companies do it?

There are a number of reasons companies choose to buy back shares. The most common reason companies buy back shares is because they think their stock is undervalued and they want to increase demand. 

‘Companies typically see buybacks as a means of giving back to investors, driving up the share price rather than paying out excess cash in the form of dividends,’ Joshua Mahony, senior analyst at IG says. 

‘Companies typically opt to buy back shares as a means of raising their market valuation, with the lower number of shares helping to improve financial metrics such as earnings per share,’ he adds. 

To calculate earnings per share (EPS), the company’s net income is divided by the number of shares in issue.

The EPS will naturally go up if a company reduces the number of shares. For example, if a company reports net income of $10million and there are 100,000 shares, the EPS is $100.

If the company then repurchases 10,000 of these shares, its EPS increases to $111.11 without any actual increase in earnings.

Whilst there are benefits associated with a buyback programme, if a firm has to facilitate the programme with a debt instrument it could suffer from credit risk.

Why are companies buying shares back now?

In the past week alone, NatwestShell and BP have announced bumper buyback programmes after posting soaring profits.

Jeff Schulze, investment strategist at ClearBridge Investments predicts it is ‘just getting started, particularly given the excess cash reserves many companies have on their balance sheets as a result of the pandemic-induced cautiousness which led many firms to hold onto cash for security’.

‘During the pandemic, when the outcome was largely unknown, many firms held onto excess cash as a cushion for potential downside risk. 

‘Now, as the world begins to recover, firms are looking to deploy this cash in the form of buyback programmes as well as capital spending.’

What should shareholders look out for?

Share repurchasing tends to be welcomed by investors as it means they’re handed cash, but there are some drawbacks.

‘While investors will almost always view a share buyback as a positive, companies will sometimes utilise them as a means to manipulate shareholding amounts and avoid other shareholders from taking a controlling stake,’ Mahony said.

Mould adds there may be some who see this ‘rapid return to corporate largesse as a worrying sign, and one that reflects the return of animal spirits and frothy, bull-market conditions within equity markets.’

History shows companies tend to buy stock back during bull markets – when shares are getting more expensive – rather than in bear ones, when shares are getting cheaper.

‘Shareholders therefore need to assess the current buyback crop on a case-by-case basis, looking at how the buybacks are to be funded, the strength of the firms’ cashflows and balance sheet and the strategy behind such plans,’ Mould says. 

‘Investors must therefore look at how a company buys back its stock.’

‘If it does so in a disciplined manner, clearly setting a maximum price that it is prepared to pay (and explaining why) then the buyback could help to create shareholder value through the efficient deployment of cash.’

‘But if a company buys shares at any price – something that could get a professional fund manager the sack for poor performance and do damage to any private investor’s portfolio, since the price and valuation paid for a stock are the ultimate arbiter of the long-term return they make from an investment – then its buyback programme should be treated with scepticism. 

‘Such indiscipline would raise suspicions that management is simply trying to massage the share price or earnings targets or both, especially in managers are using cheap debt as a source of funding rather than internally generated cash.’

Why would investors sell their shares in a buyback?    

Shareholders can either opt to sell their shares back to the company in exchange for a payout or they can hold onto the shares. For shareholders the benefit is that the offer is usually made at a premium to the market price to make it attractive.

However if they opt to keep the shares they will hold a larger percentage of the company than they did before the buyback because the number of shares in the company declines but the personal shareholding does not.

‘A company will typically buy back shares over a period of time, going into the market just like any other investor to purchase shares from those investors looking to relinquish their holdings,’ Mahony said. 

‘From a seller’s perspective, this would provide greater liquidity for when they do opt to exit their position. However, the company will not force people to sell up if it is not their plan to do so.’

Another less common method comes with the use of a tender offer, which sees shareholders state a price at which they would be willing to sell their shares.

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