Blue Chip Issue 89
Blue Chip Journal – The official publication of FPI. Blue Chip is a quarterly journal for the financial planning industry and is the official publication of the Financial Planning Institute of Southern Africa NPC (FPI), effective from the January 2020 edition. Blue Chip publishes contributions from FPI and other leading industry figures, covering all aspects of the financial planning industry.
Blue Chip Journal – The official publication of FPI. Blue Chip is a quarterly journal for the financial planning industry and is the official publication of the Financial Planning Institute of Southern Africa NPC (FPI), effective from the January 2020 edition. Blue Chip publishes contributions from FPI and other leading industry figures, covering all aspects of the financial planning industry.
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BLUE<br />
CHIP<br />
INVESTMENT | Economy<br />
The increasing popularity<br />
of share buybacks<br />
Schroders’ research shows that buybacks became more widespread in 2022, with<br />
some markets narrowing the gap with the US, where they’re most common.<br />
Kondi Nkosi, Country Head<br />
South Africa, Schroders<br />
Companies on the S&P 500 index spent $3.9-trillion<br />
buying back their own shares in the five years to 2022.<br />
This surpasses the $2.5-trillion they paid out in dividends<br />
over the same period. Buybacks divide opinion but one<br />
thing is clear: corporate buying has provided an incremental<br />
source of demand for US shares.<br />
Our new research confirms that buybacks continued to be more<br />
popular in the US than in other major markets in 2022. But that<br />
gap narrowed – with their use becoming more widespread in the<br />
UK, Europe and Japan. Buyback activity will always fluctuate over<br />
time, and one year doesn’t make a trend. But as a tailwind for equity<br />
demand and a mechanical boost for earnings per share numbers,<br />
their increased popularity outside the US is worth keeping an eye on.<br />
Why buybacks are a divisive subject<br />
Share buybacks divide opinion. On the one hand, they are a way<br />
for company management to return excess cash to shareholders<br />
in a way that is less binding than a dividend increase. And they<br />
can be more tax efficient for investors as capital gains are often<br />
taxed at a lower rate than income. On the other hand, they<br />
are open to criticism about being open to manipulation by<br />
management. The same earnings divided by a smaller number<br />
of shares leads to an increase in earnings “per share”. If executive<br />
remuneration is naively linked to earnings per share growth<br />
this could be enriching management at the possible expense<br />
of shareholders.<br />
Some also argue that they are a way for management to<br />
prop up an ailing share price, again potentially to boost their<br />
compensation. But the counterview is that if management<br />
believes their shares to be undervalued then this would be the<br />
best time to buy back their shares. An increase in buybacks may<br />
also signal an absence of profitable investment opportunities<br />
for the company concerned. So, rather than a positive, they<br />
could be interpreted as a negative. One indication of the<br />
strength of feeling about buybacks is that US policymakers have<br />
recently introduced a “buyback tax”, forcing companies to pay<br />
tax amounting to 1% of the value of any buybacks. This came<br />
into effect on 1 January 2023.<br />
US still leads buybacks, but UK and other markets closed the<br />
gap in 2022<br />
Based on our calculations, 45% of large US companies bought back<br />
at least 1% of their shares during 2022 (net of any shares that were<br />
issued). This is broadly in line with the average of the three years<br />
before Covid (buyback activity dropped dramatically in 2020,<br />
distorting any calculations encompassing this period).<br />
More unusually, UK companies almost matched the US on this<br />
basis last year (Figure 1). The proportion of UK companies buying<br />
back at least 1% of their shares soared to a record high in 2022.<br />
There has also been a rise in buyback activity among Japanese,<br />
French and German companies. Activity remains limited in<br />
emerging markets. In Japan’s case, many companies are valued<br />
at less than the book value of their shares and are hoarding<br />
cash. With regulators keen to see improvements in firms’ capital<br />
efficiency, buybacks can be considered one effective use of that<br />
cash, especially if shares can be bought back at a cheap valuation.<br />
Buybacks are less common among smaller companies<br />
Intuitively, smaller companies are less likely to engage in buyback<br />
activity and more likely to issue new shares than larger companies.<br />
Smaller firms are typically growing quicker and so potentially need<br />
the extra capital. This may also explain why emerging market<br />
companies have been less keen on buybacks. We can see this effect<br />
by comparing the proportion of large-cap companies buying back<br />
34 www.bluechipdigital.co.za