Is shares buyback a good thing?

You may have heard of shares buyback but clueless as to what it does. A shares buyback is for all intents and purposes, the purchase of shares of a company, by the said company. To achieve that, a company repurchases its own shares from, in most cases, the open market.

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What are the effects of a shares buyback?

Every company listed on a stock exchange has a certain number of outstanding shares which are in circulation. When a company repurchases its own shares, it does so with the intent of taking those shares out of circulation. That means, shares are purchased and parked in the treasury of the company. When shares are taken out of circulation, there are lesser numbers of outstanding shares. This makes each outstanding shares more valuable.

Fabled fund manager, Peter Lynch, in his book, One up on Wall Street, approves of shares buyback and has this to say:

“When stock is bought in by the company, it is taken out of circulation, therefore shrinking the number of outstanding shares. This can have a magical effect on earnings per share, which in turn has a magical effect on the stock price. If a company buys back half its shares and its overall earnings stay the same, the earnings per share have just doubled. Few companies could get that kind of result by cutting costs or selling more widgets.”

To illustrate, Company X has 100 outstanding shares and made RM10,000.00 in profits, in a particular year. That equates to an earnings per share (EPS) of RM100.00. However, Company X embarked on its shares buyback programme and repurchased 50 outstanding shares. Hence, there are only 50 outstanding shares left and each share is more valuable because each share has an EPS of RM200.00 (instead of an EPS of RM100.00).

Shares buyback and payment of dividend are perceived as fulfilling the same agenda, i.e. rewarding shareholders. Dividend payment disburses a portion of the profit of the company to shareholders, and is tangible. On the other hand, share buyback is rather an intangible reward to shareholders because its aim is to increase the “value” of your shareholding, making it more “valuable”.

As for me, I’d rather have my dividends, unless I can have both.

What are the criteria for shares buyback?

Firstly, for a company to embark on a shares buyback program, it must first have the means to do so i.e. ample cash lying around. This is because cash is obviously required to purchase shares in the open market. This can be interpreted as a good indication that a company has a good cash reserve to buyback its shares unless that means is supported from borrowings (which is never a good thing). Apple recently took advantage of the preferable taxation cuts to repatriate cash which is stored away, from the USA, to buyback $100 billion worth of stocks. Obviously, it has a stockpile of money to burn.

Secondly, it must satisfy itself that it has no immediate use for the cash which may generate more value than shares buyback. For example, if a company had the resources to expand its production or to diversify into another business, where great wealth can be made, it should utilise those resources, as capital for that venture, instead of buying back shares.

Lastly, shares buyback must be done when share prices are reasonable and that the company should never overpay for the shares repurchased. A company may choose to repurchase shares especially when share prices are low – a plan which is adopted/proposed to be adopted by Malakoff, MYEG and George Kent.

On top of shares buyback, Malakoff is also offering a generous dividends, which for me, is a great bonus.

Conclusion

Shares buyback is also a good indication to gauge the performance of a company’s managerial decisions. If shares buyback is initiated at a wrong time or for a wrong purpose, it is very likely that management decisions are impacted for an ulterior or incompetent reason which may be detrimental.

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