Share repurchases, or share buybacks, have gained popularity in the last two decades.
According to a report from Goldman Sachs, stock buybacks initiated by companies part of the S&P 500 index might touch $925 billion in 2024, up 13% year over year, and Goldman estimates buybacks to rise by 16% to $1.075 trillion in 2025.
These numbers are increasingly significant, given that in 2010, buybacks totaled just $319 billion.
What are share repurchases?
A company has a few ways it can use profits.
It can either reinvest the profits back into the business to grow and expand further, or it can reinvest in different ways by acquiring other businesses. Extra cash can be used to pay down debt or to reward shareholders directly by paying a dividend.
Stock buybacks are another capital allocation option where the company can use extra cash to repurchase its outstanding shares.
Generally, a buyback program must be established and authorized by a company’s Board of Directors. The buyback amount and expiration date are then specified.
For example, a company may issue a press release stating that its board has approved a $1 billion buyback program that would take place between January 2023 and December 2025.
A buyback can be done via different methods. These include:
- Open Market Repurchase: Here, the shares are repurchased at the current market price.
- Tender Offer: Here, the company issues shareholders an “offer to purchase” the shares. Shares are typically repurchased at a premium to the current market price, giving shareholders an incentive to sell their shares back to the company.
Why does a company do stock buybacks?
There are several reasons for companies to repurchase their shares:
The stock may be undervalued
The company’s management may believe its stock is undervalued and initiate an aggressive share repurchase program. For example, during the bear market of 2022, shares of social media giant Meta Platforms fell over 76% from all-time highs.
Meta brought back over $28 billion of shares in 2022 and initiated a buyback program totaling $40 billion in 2023. The company’s board believed buying back company stock was a good use of capital and aggressively bought back shares:
You can see how well this paid off. Money invested in Meta’s shares in 2022 and 2023 has essentially doubled in value already.
Because management bought Meta stock, and Meta’s shares increased in value, management directly increased the value of the overall business and created value for shareholders.
Repurchasing shares when the stock is undervalued is an effective use of capital.
Buybacks are tax-efficient
Most investments are taxable unless held in tax-advantaged accounts such as an IRA. For instance, long term shareholders get taxed at the capital gains rate for the dividends they receive.
Share buybacks are unique because, unlike dividends, repurchasing shares is not a taxable event. This can make share buybacks a more effective way to increase the real returns for investors than dividends when shares are bought at reasonable prices.
Earnings-per-share growth
Another critical reason for buybacks is that corporate action has a positive impact on a company’s earnings growth. Let’s say a company with 100 million outstanding shares earns a profit of $200 million annually. So, the company’s earnings per share (EPS) will be $2. Now, if the company buys back 10 million shares, its share count will reduce to 90 million. Given its $200 million in earnings, its EPS will now be 11% higher at $2.22 per share.
Here, the buyback program was used to increase earnings-per-share for investors and increase the value of each stock.
However, it’s important to understand that buybacks are often called an “artificial” way to boost earnings-per-share, because the company’s earnings didn’t actually grow – the company just made a capital allocation decision to reduce the number of shares outstanding.
Buybacks are non-binding
Over the years, we have seen that when a company cuts or revokes its dividend, the stock price falls significantly. So, a company will generally avoid paying a dividend unless it is fairly certain the payout can be maintained across business cycles.
Comparatively, when a buyback program is shelved, it is not met with a similar disdain from Wall Street. A buyback program can give companies more flexibility than a dividend program.
Apple’s Stock Buybacks
Apple began its share repurchase program in 2012 and has demonstrated a commendable track record of returning capital to investors. In 2018, Apple initiated a $100 billion share repurchase program, the largest ever in corporate history.
This year, the tech giant bought back an additional $110 billion in shares, surpassing its own record in the process. Apple ended the March quarter with $160 billion in cash.
Apple’s buyback program has consistently increased adjusted EPS, which has certainly contributed to its 285% return (31.5% CAGR) over the past 5 years.
Pros and Cons of Stock Buybacks
Analysts and investors view stock buybacks as a positive event. They are a shareholder-friendly way to allocate capital, but there may be a few drawbacks to the process.
Pros:
- Increases EPS: Share buybacks can enhance a company’s EPS, making it more attractive to investors.
- Capital appreciation: The reduction in outstanding shares can lead to a rise in stock prices, benefiting existing shareholders through capital appreciation.
- Tax efficiency: Share repurchases can be a tax-efficient way to return excess cash to shareholders compared to dividends.
- Offset dilution: Growing companies often issue stock options to recruit and retain top talent. When these stock options are exercised, they increase the total outstanding shares, diluting existing investors. Share repurchases can offset this dilution.
- Capital return flexibility: Companies can engage in infrequent share repurchases, whereas dividend payments are expected to be made on a regular schedule. If a company is looking to return capital to shareholders infrequently, share repurchases might be a good method.
- Signal of confidence: Companies engaging in share buybacks often signal confidence in their future, potentially boosting investor trust and sentiment.
Cons:
- Misuse of funds: Companies might engage in share repurchases even when their stock is not undervalued. This could be seen as a misuse of funds that could have been used for more productive investments or to strengthen the company’s financial position.
- Opportunity cost: The funds used for share repurchases could be invested in projects that would generate a higher return. Opting for buybacks over investments in research and development, acquisitions, or other growth opportunities may limit the company’s long-term potential.
- Financial engineering: Some critics argue that share repurchases can be a form of financial engineering, artificially boosting stock prices without addressing underlying operational challenges.
- Debt-funded buybacks: If a company funds share repurchases through debt, it could lead to increased financial leverage, making the company more vulnerable to economic downturns and interest rate fluctuations.
Final Thoughts
Share buybacks can be used to create value for shareholders when done for the right reasons, such as if the stock trades at a discount to its intrinsic value. In the majority of cases, buybacks are a way for companies to return capital to shareholders, which enhances shareholder returns over time.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold positions in any of the stocks mentioned in this article. Thank you for reading, and happy investing!
