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Exploring the Pros and Cons of Share Buybacks: Boosting Value or Misusing Funds?

Several top companies have engaged in significant share buyback programs which can often give an opportunity to a trader. Here are a few examples:

1. Apple Inc. (AAPL): Apple has consistently been a leader in share buybacks, with a history of massive repurchase programs. In recent years, they have bought back billions of dollars worth of their own stock.

2. Alphabet Inc. (GOOGL): Alphabet, the parent company of Google, has also been actively involved in share buybacks. They have implemented substantial repurchase programs to return value to their shareholders.

3. Microsoft Corporation (MSFT): Microsoft has consistently bought back its shares over the years. In recent times, they have executed substantial buyback programs, highlighting their commitment to returning capital to investors.

4. Berkshire Hathaway Inc. (BRK.A, BRK.B): Warren Buffett's conglomerate, Berkshire Hathaway, has a history of share buybacks. Buffett has stated that they will continue to repurchase shares when they believe the price is favorable.

5. JPMorgan Chase & Co. (JPM): JPMorgan Chase, one of the largest banks in the United States, has conducted significant share buybacks as part of its capital management strategy.

6. Procter & Gamble Company (PG): Procter & Gamble, a consumer goods company, has been active in repurchasing its shares to enhance shareholder value.

A share buyback, also known as a stock repurchase, is a strategic move employed by a company to acquire its own outstanding shares from existing shareholders. This financial manoeuvre can be executed in two primary ways:

1. Open Market Buyback: The most common method involves the company purchasing its shares from the open market, similar to how individual investors buy shares through a broker. However, before initiating the buyback process, a company must obtain approval from its shareholders, usually during the Annual General Meeting.

2. Tender Offer: This method is relatively less common and involves the company announcing a tender offer, whereby all shareholders have the opportunity to submit the price at which they are willing to sell their shares.

Share buybacks and dividend pay-outs are both mechanisms through which a company can return money to its shareholders. This occurs when a company generates surplus cash that exceeds its investment requirements or when viable acquisition prospects are limited. In the past, dividends served as the primary means of rewarding shareholders, particularly when few individuals held a portfolio of company shares outside of pension funds. Successful companies would set aside a portion of their profits to distribute regular dividends, usually twice a year, encouraging investors to buy and hold shares. An increase in dividend pay-outs was perceived positively, indicating the company's strength, while a dividend cut signalled a lack of confidence in its future performance. Dividends could be reinvested in the company's stock, used to purchase shares in other companies, or utilized for personal spending purposes.

Certain companies gained acclaim for consistently providing high and regular dividends, attracting both small investors and large funds. For instance, Lloyds Banking Group, a prime example, historically paid dividends exceeding 30 pence per share annually, making it a favourite among value stock enthusiasts. However, the financial crisis of 2008 abruptly halted Lloyds' dividend payments, and it took the bank seven years to resume dividends, albeit at a significantly lower rate of just 1.24 pence per share, far from its glory years.

Advantages of Share Buybacks:

In contrast to dividends, which adhere to a fixed timetable, a company can announce a share buyback at any time. By utilizing its resources, sometimes even borrowing funds, the company repurchases its own shares. This action reduces the number of shares in circulation, immediately increasing the earnings per share ratio and enhancing the attractiveness of the stock, thereby boosting the value of existing shares. Shareholders benefit from this development, as do company executives whose bonuses and stock option schemes are often tied to share price performance. Buybacks offer greater flexibility than dividends in terms of distributing funds to shareholders. Unlike dividends, buybacks have no specified timeframe, enabling the company to slow down or halt repurchases if market conditions deteriorate. Additionally, buybacks are subject to capital gains tax, which is only payable when an investor sells their shares. In contrast, dividends are subject to income taxes once received. If a dividend-paying company chooses not to distribute dividends or reduces their amount, it reflects poorly on the company and often results in sharp sell-offs by investors. Conversely, the initial announcement of a buyback is generally perceived as an unexpected bonus.

Borrowing to Finance Stock Buybacks:

Concerns have been raised about buybacks, particularly when they are favoured by executives over dividends. One criticism is that stock buybacks do not contribute to a firm's productivity, especially when a company borrows money to fund the repurchase instead of utilizing cash generated from its core activities. While borrowing costs were historically low, making it sensible to borrow for investments in plant and machinery, research and development (R&D), and other activities that contribute to future sales and profitability, taking on debt solely for buybacks does not generate additional revenue and adds interest liabilities to the balance sheet.

Other Concerns and Considerations:

Even when a buyback is financed using cash reserves, questions often arise regarding why executives choose this route. Spare cash could be utilized for corporate expansion, employee training, acquiring new equipment, reducing debt, or acquiring competitors. Some argue that if executives are unable to identify opportunities for reinvesting excess cash into the business, they may need to be replaced. After all, the company's ability to generate surplus cash indicates its success, making reinvestment a logical step. Critics contend that executives may opt for stock buybacks because a significant portion of their compensation is linked to higher share prices. Furthermore, the rise in share prices following a buyback announcement primarily benefits short-term speculators rather than long-term value investors. The resulting boost in stock price may create a false impression of a thriving company, masking financial engineering rather than genuine organic growth.

Supporters of Buybacks:

In contrast, proponents argue that investors favour stock buybacks, and maximizing shareholder value is a responsible action for executives to take. Reinvesting all excess funds is not always prudent, as poor management decisions can lead to unfavourable outcomes. Returning money to loyal stockholders can be a reasonable course of action. However, many believe that increasing dividends is a preferable method. Firstly, it rewards long-term investors in a way that buybacks do not. Additionally, dividends provide shareholders with a cash payment that they can utilize as desired. On the flip side, shareholders have no control over dividend payment timing and are required to pay ordinary income tax on dividends. With buybacks, investors have the flexibility to choose when they sell their shares, and they are subject to capital gains tax rates, which decline after holding the stock for more than a year. Many investors prefer this arrangement.

Impact of the Pandemic:

The popularity of share buybacks declined during the pandemic due to various reasons. Some companies voluntarily halted their share repurchase programs, while others had no choice due to economic uncertainties. The U.S. Federal Reserve imposed restrictions on major U.S. financial institutions, temporarily prohibiting both buybacks and dividend pay-outs. However, these restrictions have been lifted, and buybacks have regained momentum, returning to pre-pandemic levels. Notably, U.S. tech giants dominate the buyback landscape, with the tech sector accounting for $56.4 billion of buybacks, representing 36.1% of all stock repurchases in the first quarter of 2021. Apple led the pack, repurchasing $18.8 billion worth of its stock alone in the first three months of 2021. Apple and Alphabet recently announced plans to return $90 billion and $50 billion, respectively, to their shareholders. Additionally, Microsoft unveiled its largest-ever buyback program, committing to repurchase $60 billion of its shares, with no end date and the option to terminate at any time. The announcement coincided with two Democrat senators proposing additional taxes on buybacks while introducing the "Stock Buyback Accountability Act," aimed at benefiting workers rather than solely enriching stockholders. Ultimately, while buybacks often provide a short-term boost to a company's shares, long-term value stems from financial stability, growth prospects, and profitability. Identifying businesses with these characteristics while their shares are reasonably priced is the key to successful investing.

In conclusion, traders should be aware that the availability and timing of share buybacks can vary, and it is essential to verify the current status of a company's buyback program. Engaging in a share buyback CFD trading strategy entails speculating on stock price movements during a buyback program, anticipating an increase in value due to the reduced number of outstanding shares. It is common for traders to observe a rise in stock prices following the announcement of a share buyback by a company.


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