During times of serious economic downturn and surging cost inflation for companies, it may come as a shock to you just how many blue-chip companies are buying their own shares in 2022.
According to Proactive’s calculations, one-fifth of FTSE 100 companies are in the market buying their own shares or previously completed a programme this year.
Blue-chip groups are well on track to surpass the prior record of £34.9bn of buybacks in 2018, according to AJ Bell data.
You must be wondering, why do companies pursue buybacks?
There are half a dozen clear reasons in favour of share buybacks, either for the companies themselves or investors.
Arguably the most prominent argument is the tax efficiency of such programmes.
In most cases, the buyback qualifies for capital treatment, which is taxed at a lower rate than dividends (ordinary income tax).
Secondly, dividends are traditionally most useful to smaller investors rather than institutional ones.
Potentially the most significant indicator to determine a company’s share price is earnings per share (EPS), which is the proportion of profit allocated to each share of stock.
During a buyback, companies reduce the assets on their balance sheets but increase returns on those assets. So, by decreasing the number of shares and retaining profitability, EPS advances higher.
Shareholders who chose to not offload their shares, therefore, own a greater percentage of the company.
Additionally, those who retain shares would be entitled to a bigger share of future dividends – if there are any – given the enhanced stake, Russ Mould, AJ Bell investment director, said.
This provides a greater potential for bigger value gains and makes them look more financially attractive as the remaining shares’ value climbs.
Next, a company usually purchases its own shares when it believes them to be undervalued, which investors could deem as a vote of confidence.
It can also be a good indicator of how the company’s board anticipate the coming years to be in terms of financial returns from share price hikes.
Companies also pursue buyback programmes to dispose of excess cash and indicate to investors they view reimbursing shareholders as more valuable than reinvesting in other assets.
“If a company is generating surplus cash it can return it to shareholders and let them decide what to do with it, rather than splurge it on an unnecessary acquisition or capacity increases,” Mould added.
Finally, this reason comes down to the simplicity of buybacks.
“Ultimately, it is easier to start or stop a buyback than it is to cut or cancel a dividend – there’s likely to be less blowback from shareholders,” Mould told Proactive.