Share buybacks; what are they and how do they benefit investors?
On the 24th of April, Apple Inc. released an update detailing its Q2 Earnings while also announcing a $100bn capital return programme or “share buyback”. This subsequently prompted a 4% jump in the share price during afterhours trading. Share buybacks are a widely acknowledged method used by companies to return value to shareholders, but how do they work and what benefit do they have?
A share buyback programme is a strategy used by a company when the board thinks that its shares are undervalued and it has excess cash available. This is typically a sign of management confidence in the shares. The shares are purchased directly from the market, although on occasion there is an option for shareholders to tender shares back to the company at a fixed price by way of a corporate action. This is likely not to carry the same dealing charges as a sale in the market for the shareholder. Once shares have been bought back by the company, the shares are either held in Treasury or cancelled and are then no longer in issue. Reducing the number of shares in issue leads to an increase in earnings per share (EPS), heightening the market value of the remaining shares; this benefits the shareholder twofold, with an increase in value and increased ownership in the company.
The alternative way a company can return money to shareholders is through payment of dividends. However, the tax consequences of doing so can be less favourable for both the company and the shareholder. In most regions, the capital gains associated with share buybacks are taxed more favourably than the income attributable to dividend payments.
Buybacks are generally considered an appropriate use of capital, so long as the company can demonstrate it is not overpaying for its shares. A common criticism of buybacks is that they can be a sign of a company running out of steam. A strong management team will recognise this and strike a balance between retaining enough capital to fund future growth opportunities and returning excess cash to shareholders.