This is an audio transcript of the Money Clinic podcast episode: ‘The Five Minute Investor from Money Clinic — Are share buybacks good news for investors?’
Claer Barrett
Can you speak the language of money or are you one acronym short of an investment picnic? Welcome to the Five Minute Investor from Money Clinic. I’m Claer Barrett, the FT’s consumer editor, and I’ll be teaching you what you need to know about key investment terms in the time it takes to make a cup of coffee. Each week we take one investment term selected by our listeners and challenge a top investment commentator to defang the financial jargon in just five minutes.
Joining me this week in the FT studio is investment columnist Stuart Kirk, a former city slicker, portfolio manager and research chief, who now writes our weekly Skin in the Game column. Stuart, the topic I want to quiz you on is share buybacks. To start with, give us your five-second definition.
Stuart Kirk
It’s when a company buys its own shares in the market and deletes them.
Claer Barrett
OK, I’m starting the clock. You have five minutes to tell us more about share buyback starting now. (Timer starts ticking)
Stuart Kirk
Of all the investment topics out there, share buybacks are probably the most controversial on whether they are good for investors or not. They are definitely a very easy thing to explain. After a company goes through all the rigmarole of doing an IPO and selling equity, down the track suddenly decides to buy its own shares back. And how does it do that? It simply takes its own money, goes into the market and buys its stock.
Claer Barrett
Why would it do that?
Stuart Kirk
Think about what happens. Company takes its own money and buys back its own stock. So there are fewer shares out there. So the size of the pizza, the size of the pie, shrinks a little bit because money has gone out the door. But the shareholders who are left to get a bigger slice of the pie, a bigger slice of the pizza, those two things, in theory, should balance out. From a valuation point of view, valuation purists would say the company is no more valuable after a share buyback than before. So why do it? Well, optically, there are fewer shares. So your earnings per share improves. That’s just mathematics. And there are some people who say bosses like to do it because very often they’re rewarded. Their pay is linked to earnings per share. So, tick, good for them.
Another reason they may want to do it is because it says to the market, it says to investors, we don’t spray your money around willy nilly. We’re very, very disciplined. We can’t see any better opportunity out there than our own stock. We are going to buy it. So it’s a signalling mechanism that management is disciplined.
A third and very good reason that they may do it is because their shares are undervalued. So even though you have to pay to get a bigger slice of the share, if you’re paying less than that slice of pizza is worth, that is good for existing shareholders and good for the company. Unfortunately, very often companies buy at the peak, they buy when their shares are doing very well. This is actually the reverse of what you should be doing. You should be buying your shares when they are low.
Claer Barrett
OK. There’s lots of companies who are doing share buybacks, both in the US and in the UK and elsewhere. Give us a few examples of what’s happening.
Stuart Kirk
Yeah. So there are two good examples of what I was just talking about in the market. Uber is one, for example, the mega $9bn share buyback. Now that’s a very expensive, sexy US company. You may wonder: is that really the best use of the company’s money buying its own shares? At the other end of the spectrum, a number of UK stocks have recently announced share buybacks, in particular banks. Now, UK banks are cheap. Indeed, the UK market is cheap. So it is very, very possible that it is a great time at the moment for UK banks and UK companies to be buying its own shares because they’re trading more cheaply than they otherwise would be.
Claer Barrett
And then when the market comes back, it comes back.
Stuart Kirk
If the market comes back, the slice of the overall pizza and your slice of it both increase.
Claer Barrett
If a stock that you hold announces that it’s doing a share buyback, what do investors need to do?
Stuart Kirk
The great thing about this for investors is they can just sit there, revelling in the fact that their slice of the company has grown. They own more of the company than they did before. Hopefully the share price will appreciate on the back of the extra buying and the extra discipline that management is showing, and hopefully management will have bought at a good time that they can just sit there and enjoy the gains.
Claer Barrett
And is there any reason why share buybacks hold downsides for investors?
Stuart Kirk
Yes. As I mentioned before, if the company buys high, it pays too much for the shares than their intrinsic worth, then that is bad for existing shareholders. Another criticism of share buybacks is that they do it when management has run out of innovative ideas in terms of investment opportunities. That would be another bad reason.
Claer Barrett
Do you think that we’re going to see more share buybacks as the year progresses?
Stuart Kirk
Share buybacks are still extremely popular. Roughly 40 per cent of UK stocks, two-thirds of US stocks do them every single year. They tend to fluctuate in popularity with interest rates because companies tend to borrow cash in order to buy their own shares. So when interest rates rise, like in 2023, there were fewer than the years before it. Now that rates have come off a little bit, that’s why you’re seeing so many at the beginning of 2024. (Alarm sets off, timer ends)
Claer Barrett
Stuart, that timer means that the five minutes are up. Thank you for explaining share buybacks to our listeners. If you would like to read more of what Stuart writes about for the FT, there is a link in today’s show notes to read his latest Skin in the Game column, absolutely free.
We firmly believe on Money Clinic that there are no stupid questions. The only stupid thing would be not to ask if there’s something about money that you don’t understand. So if there’s an investment term, a piece of jargon, a phrase you’ve heard that’s baffling you, and you’d like me to unpack it in the studio with an expert, then get in touch with us. Our email address is money@ft.com. Or you can contact me or send me a DM on Instagram. I’m @ClaerB.
Brand new Money Clinic episodes will be coming soon, and if you can’t wait until then, have a browse through our back catalogue where you can find hundreds of episodes. Or click on my suggestions in today’s show notes. Finally, the Five Minute Investor is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that you’ll need to find an independent financial adviser. Tune in next week for another Five Minute Investor. Goodbye.
