Oran A. Hall | Good and bad of share buybacks
THERE IS always something happening on the stock exchange. The market is soft, but perhaps because of it, to some extent, some listed companies are buying back their shares from investors, and it seems more positive than negative.
The GraceKennedy Group announced last month its intention to implement a share buyback scheme, intending to drive up the price of its shares by reducing their supply.
The company stated that it considers the share price to be below its true value and wants to increase shareholder value by raising earnings per share.
This is not to say that the group is not doing well. Its annual revenues increased 10.50 per cent over the previous year to a record level, but its net profit fell by 15 per cent. The chief executive officer of the group noted that the stock price was about the same as the book value – clearly unsatisfactory to him and the board.
Among other listed companies that find attraction in the share buyback scheme is the JMMB Group, which announced that its board has approved one for execution in the 2023 financial year, concerned that the stock is trading below the price earnings ratio and price to book value ratio of the stock market and the financial sector.
In 2022, First Rock also announced that its board passed a resolution to buy back up to 10 per cent of the company’s shares, amounting to US$33 million on the open market, because the stock was trading below net asset value and the initial public offering (IPO) price. The reason stated for this action is to “unlock value” for the shareholders of the company.
The strongest reason for stock buybacks is to boost the price of the particular stock. But there are other reasons. One is to gather shares to distribute to employees through stock options at a later stage and to thwart hostile take-overs.
Generally, the process may begin by management making a recommendation to the board, which then approves the relevant resolution. The stock exchange is notified, and later, the shareholders, through a public announcement. Typically, the number of shares to be purchased and the period of the buyback are also announced.
Usually, the company pays for the shares from past profits it has not distributed which, by the way, belong to the shareholders. The number of issued shares – those in the hands of the shareholders – falls correspondingly, so the balance sheet still balances as both are on different sides of it.
The shares that are bought back, termed treasury shares, not being in the hands of the shareholders, do not come into play and are not factored into the calculation of earnings per share or into the distribution of dividends.
In terms of dividends, the dividends per share ratio increases if the company distributes at least the same total amount of dividends as before, but it is also possible for the amount of dividends per share to be maintained, that is, in a case in which the company declares a set amount of dividends for each unit of stock.
This would not make any difference to shareholders who did not sell any of their shares, but it would mean less to those who sold some of their holdings.
With fewer shares in the hands of the shareholders overall, those shareholders who did not sell any of their shares would hold a higher percentage of the issued shares of the company. This would not necessarily be the case for those who sold a portion of their shareholdings for they could see a dilution depending on the proportion of their holdings that they sold to the company.
One benefit that would accrue to shareholders who opt to sell is the cash they would receive for their shares, thus giving them some liquidity, which could be valuable, especially in a soft market. It is also possible that the participation of the company in the market could cause the price of the shares to increase during the buyback period or periods.
After the buyback, the fact that there are fewer shares on the open market tends to cause the price of the stock to increase. Even if earnings remain the same as in the period before the buyback, the fact that there are fewer units of stock means that the earnings per share would increase. In such a scenario, and if the price remains unchanged, the price earnings ratio would fall, thus making the stock more attractive, likely boosting demand and its price.
One reason companies engage in share buyback schemes is that they care about the price of their shares, for it tells a story about how the investing public sees the companies themselves, and it matters to them that they are creating value for their owners – the shareholders.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email firstname.lastname@example.org