Share buy backs

[justakiwi]

Can someone please explain to me the purpose of company share buy backs?

[Aaron]

Can someone please explain to me the purpose of company share buy backs?

Not sure but this is Mercury's explanation.

Mercury Chair Joan Withers said the Board’s view is that a purchase of the company’s shares at current market prices is an efficient use of excess balance sheet capacity that also reflects Mercury’s desire to maintain capital flexibility for future value-enhancing initiatives for its shareholders.

“The Board believes that the buyback is a prudent method of addressing the company’s low gearing relative to its target capital structure and is an efficient way of returning capital to shareholders,” said Mrs Withers. The buyback will bring the company’s gearing levels near 2.0x for debt to EBITDAF, consistent with the conservative end of Mercury’s target range of 2.0x to 3.0x.

Mrs Withers said that holding the shares as treasury stock reflected the company’s desire to maintain capital flexibility. This will add to the 1.6% of shares already held as treasury stock from Mercury’s buyback in FY2014.


So they buy their own shares on market with debt? So they have shares to sell if they need additional capital to provide "capital flexibility". Although they would be less likely to need capital flexibility if they didn't buy back their shares and left their "excess capacity" on their Balance Sheet. They could have used their excess capacity to bump up our dividends.

I don't really know either, maybe check to see if Management bonuses depend on an increasing share price or if consultants or brokers get fees for pointless fluffing around. Maybe it is just sensible to have more debt in a world trying to destroy the value of debt through inflation? Certainly wish I had been less scared of debt over the years.

I will need to wait with you for a more knowledgeable poster to provide a purpose for it all.

[Snoopy]

Can someone please explain to me the purpose of company share buy backs?


Here is a quote from Chapter 18 of "The Buffettology Workbook" which should go a long way to answering your question.

"Let's say a company has 100 million shares outstanding and Warren owns 10 million of these shares, which equates to owning 10% of the entire business. If the company goes into the stock market and buys back 40 million of its shares, it will have only 60 million shares outstanding. Warren's ownership interest in the business would have increased from 10% to 16.6%. His ownership in the company increased without investing any more money. The company's own capital was used to increase his ownership interest."

"Now consider this: If the company had paid out the money that it spent on buying back shares, Warren would have had to pay income tax on his portion of the dividends, which means he would have about 30% less money to invest with. By having the company repurchase its own shares, Warren is able to avoid the tax man and in the process increase his own percentage of ownership of the business."

SNOOPY

[justakiwi]

OK. So share buy backs are good for shareholders with a significant holding in a company? (But less useful for small investors). What affect does a buy back have on the share price? How does the company decide what they are prepared to pay for the shares or does it not really matter what price they get them at?




Here is a quote from Chapter 18 of "The Buffettology Workbook" which should go a long way to answering your question.

"Let's say a company has 100 million shares outstanding and Warren owns 10 million of these shares, which equates to owning 10% of the entire business. If the company goes into the stock market and buys back 40 million of its shares, it will have only 60 million shares outstanding. Warren's ownership interest in the business would have increased from 10% to 16.6%. His ownership in the company increased without investing any more money. The company's own capital was used to increase his ownership interest."

"Now consider this: If the company had paid out the money that it spent on buying back shares, Warren would have had to pay income tax on his portion of the dividends, which means he would have about 30% less money to invest with. By having the company repurchase its own shares, Warren is able to avoid the tax man and in the process increase his own percentage of ownership of the business."

SNOOPY

[blackcap]

OK. So share buy backs are good for shareholders with a significant holding in a company? (But less useful for small investors).

I think its the same for all shareholders. Every 1 share counts the same in % terms.

[Banksie]

Here is a quote from Chapter 18 of "The Buffettology Workbook" which should go a long way to answering your question.

"Let's say a company has 100 million shares outstanding and Warren owns 10 million of these shares, which equates to owning 10% of the entire business. If the company goes into the stock market and buys back 40 million of its shares, it will have only 60 million shares outstanding. Warren's ownership interest in the business would have increased from 10% to 16.6%. His ownership in the company increased without investing any more money. The company's own capital was used to increase his ownership interest."

"Now consider this: If the company had paid out the money that it spent on buying back shares, Warren would have had to pay income tax on his portion of the dividends, which means he would have about 30% less money to invest with. By having the company repurchase its own shares, Warren is able to avoid the tax man and in the process increase his own percentage of ownership of the business."

SNOOPY

This makes sense to me if the company buy the shares and cancel them. I am less clear of the effect of holding the shares as treasury stock.

Are they not just taking on debt to increase their assets? They will then benefit from any increase in share price and dividend payouts.

[justakiwi]

Yes that’s true, but I was looking at it more from the point of view of dividends and tax. A share buy back looks to be preferable for someone with huge numbers of stock, whose dividend income (and thus tax) would be significant. Whereas for someone like me, a dividend pay out/DRIP is a greater benefit than a % increase in my holding under a buy back.

Unless of course, I am not fully understanding this, which is very possible ;)


I think its the same for all shareholders. Every 1 share counts the same in % terms.

[Snoopy]

Yes that’s true, but I was looking at it more from the point of view of dividends and tax. A share buy back looks to be preferable for someone with huge numbers of stock, whose dividend income (and thus tax) would be significant. Whereas for someone like me, a dividend pay out/DRIP is a greater benefit than a % increase in my holding under a buy back.

Unless of course, I am not fully understanding this, which is very possible ;)


The number of shares an investor holds in a company makes no difference to the argument justakiwi. A dividend is taxable, and the funds you reinvest via a DRIP have to be declared as income, and tax is paid. After tax is paid the residual from the gross dividend funds that remain after tax has been paid are reinvested in new shares, increasing the number of shares in circulation, under the DRIP.

If instead of paying a dividend the company bought back its own shares, and cancelled them, then you would have the same number of shares but each share would be worth more and you would have no tax bill. Theoretically the increase in the value of your existing shares would exceed the increase in your wealth more than from the incremental increase in the number of shares you own under the alternative scenario of the DRIP. This is because under a DRIP you pay tax, but if that same money was instead invested in a share buyback you do not pay tax,

SNOOPY

[Snoopy]

OK. So share buy backs are good for shareholders with a significant holding in a company? (But less useful for small investors).


No. (see my previous post).



What affect does a buy back have on the share price?


The profits from the underlying business are spread among less shares. So if 10% of the shares are bought back, that means each shares that remains should be worth:

100/90 = 11.1% more



How does the company decide what they are prepared to pay for the shares or does it not really matter what price they get them at?


This question is not so straightforward to answer. One might argue that whatever price a company pays for its own shares will reduce the number of shares on issue and so increase earnings per share. So the price the company pays does not matter. However it is clear that the lower the share price, the more of its own shares a company is able to buy with the same money. So I would argue that the price the company pays for its shares does matter. This means a company can pay too much for its own shares, in my view.

How much is too much? Not an easy question to answer. But if a company buys back its own shares then somewhere down the track decides to issue new shares at a lower price than their buyback price, that is a sure sign the buyback price was too high.

SNOOPY

[justakiwi]

Gotcha ... thanks for the explanations :)



No. (see my previous post).



The profits from the underlying business are spread among less shares. So if 10% of the shares are bought back, that means each shares that remains should be worth:

100/90 = 11.1% more



This question is not so straightforward to answer. One might argue that whatever price a company pays for its own shares will reduce the number of shares on issue and so increase earnings per share. So the price the company pays does not matter. However it is clear that the lower the share price, the more of its own shares a company is able to buy with the same money. So I would argue that the price the company pays for its shares does matter. This means a company can pay too much for its own shares, in my view.

How much is too much? Not an easy question to answer. But if a company buys back its own shares then somewhere down the track decides to issue new shares at a lower price than their buyback price, that is a sure sign the buyback price was too high.

SNOOPY

[SBQ]

Snoopy has explained it well. At least we are in agreement :)

I do assume everyone knows that the opposite of a share buyback is when the company issues more new shares (creating the opposite effect of 'share dilution' = your % of ownership erodes and likewise the share of the profits).

[Jerry]

I understand the theory of this is logical, but it has never struck me that the price of shares is logical. It's driven by all kinds of fear/greed quotients/irrational tweets by prominent players, etc.
The present inclination of companies in the USA is to buy back their own shares, rather than distribute dividends, thus increasing corporate wealth and distributing even less to the average punter. Done on a large scale it is channeling wealth into the hands of a small percentage of people and reducing the monetary merry-go-round that supports participation in the economy..

[Snoopy]

I understand the theory of this is logical, but it has never struck me that the price of shares is logical. It's driven by all kinds of fear/greed quotients/irrational tweets by prominent players, etc.


In the short term you are probably quite right Jerry. The argument is that in the long term 'time' and 'rigorous analysis' will even out the daily market gyrating hype.



The present inclination of companies in the USA is to buy back their own shares, rather than distribute dividends, thus increasing corporate wealth and distributing even less to the average punter. Done on a large scale it is channeling wealth into the hands of a small percentage of people and reducing the monetary merry-go-round that supports participation in the economy..


You are correct Jerry if the shares being bought back are from the 'Mum and Dad investors' and those that don't sell into the buyback are 'Big Corporates'. But is that the case?

SNOOPY

[SBQ]

I understand the theory of this is logical, but it has never struck me that the price of shares is logical. It's driven by all kinds of fear/greed quotients/irrational tweets by prominent players, etc.
The present inclination of companies in the USA is to buy back their own shares, rather than distribute dividends, thus increasing corporate wealth and distributing even less to the average punter. Done on a large scale it is channeling wealth into the hands of a small percentage of people and reducing the monetary merry-go-round that supports participation in the economy..

I'm not sure if you do understand the logic of share buy backs. But since we're in NZ and like most share investors in NZ (that prefer dividends than tax free capital gains), let's assume corporate America did issue dividends instead of buying shares. So all these mom and pop small investors will get a pay. Then what? Gloat that the company they own shares in paid them a cheque while the share price remained the same (re: book value tied to market share value)?

If you say it's greed, then certainly companies like Apple will continue to incorporate in tax preferred nations, to never bring their operations to America because corporate taxes are too high. Done on a large scale, you'll find America will not produce anything. Ingenuity given away to places like China. But we can compare all these differences until the cows stop mooing. The US will always have a higher standard of living than NZ and it's well reflected in the strength of the USD currency. Investors foreign and domestic know that the whole world trades in the US equity market. If this wasn't the case, then the US would have a weak currency. (like we're seeing in NZ).

I've posted in other threads. The investment view in N. America differs greatly than the investment view in NZ. Unlike in NZ, small investors believe in being in a PARTNERSHIP of the company they bought shares in ; and not a landlord where they expect routine rental (dividend) payments. The small investor if not inclined to sell their shares will reap the benefit in higher share price. It might be a tough view to understand; at least from my observation, N. American investors know capital gains tax is a lot less than dividend income tax, and before we compare to NZ, not ALL NZ listed companies have full imputation dividend credit; the vast majority of them issue dividends at RWT. Some food for thought in this link

Link "https://www.interest.co.nz/business/77780/dividend-imputation-has-changed-how-nz-corporates-deliver-returns-shareholders-says"

[CatO'Tonic]

I've heard of companies buying their own shares back as a defensive play against hostile M&A activity as well, but not so much in NZ. I've always seen a buyback as a good sign that the management have confidence in the value of their company, or that it is undervalued by the market. MET is a good current example with a NTA of 6.96 and a share price around 5.85.
Disc: holding MET
No advice implied, novelty purposes only etc etc...