100 dollar bills

Use it or lose it – are Share Buybacks the best use of surplus cash?

In 2022 the 1,200 largest public companies in the world collectively bought back $1.3 trillion of their own shares, a record level. This year, Deutsche Bank is forecasting that the level of share buybacks will again exceed $1 trillion through 2024.

This volume of share repurchasing might seem extreme, particularly at a time when corporates are still feeling the impact of inflationary pressures and a challenging global economy. So why are companies choosing to initiate share buyback schemes?

There are a number of reasons a company might repurchase shares from the market; this includes investors’ desire for cash surpluses to be deployed, it might be used to drive up an “undervalued” share price, increasing earnings per share by decreasing the outstanding shares, un-diluting the shareholder register or reducing share capital. Only recently the Scottish Mortgage Investment Trust launched its £1bn share buyback scheme to help prop up its share price, which was deemed below market value.

For the most part, it is a case of a cash-rich company looking to return value to shareholders, who might not have seen much in terms of returns, instead of investing in growth or distributing dividends. Surely this can only be seen as a positive thing?

It isn’t always the case that a share buyback whets the appetite for investors nor does it always put the company in a more favourable position. A number of factors, including timing and the explanation given, mean that share repurchases can have an adverse intended effect. Some individuals might question whether it is an appropriate use of a company’s surplus cash. Others might argue that it contributes to an illiquid stock. Cynics might also contest that share buybacks are more easily cancelled than a dividend policy, should a company start to struggle financially.

There have been extreme scenarios when share buybacks have been used for questionable outcomes…. In April 2023, Bed Bath & Beyond crashed into administration in the US after it was no longer able to buy inventory in order to reverse its losses – since 2004, the company had spent a staggering $11.8 billion repurchasing its own shares. In 2016, Wells Fargo embarked on a multi-billion-dollar share buyback programme to mitigate the impact of a scandal whereby employees had fraudulently opened millions of unauthorized bank accounts and credit cards in customers’ names. The scheme artificially inflated its EPS, but the strategy backfired, the bank faced continued scrutiny from regulators and investors, highlighting the potential pitfalls of using buybacks as a short-term solution to broader systemic problems.

It is a fair assumption that share buyback schemes are widely used to drive better share price performance, at a time where valuations are supressed. Whatever the reason, business leaders must ensure they are clear and concise in explaining their motivations for undertaking a share buyback. Investors need assurance that the level and volume being committed does not compromise corporate strategy, financial position, operations or growth plans. Falling short on the communication will live long in the memories of shareholders.