In the beginning of this month I read that one of my companies (VER) of my Vrijheid Fonds is starting a buyback program. This made me wonder, is a buyback program good for me as a DGI?
A share repurchase or buyback means that the company is buying back its own shares from the marketplace. Together with dividend, share buybacks are options for a company to return cash to its shareholders.
Analysts predict that some huge buybacks will be announced and will be implemented in 2017. An analyst of Goldman Sachs predicts that 2017 will be a record year. I read a prognostication of around 780 billion dollar for 2017 (in 2016 it was approx. 602 billion dollar).
If a company has some money on the bank that is just sitting around, they don’t see any good opportunities for this cash, and they have paid of (most of) their debt, than there are only two options left.
They can buyback shares or pay a super dividend to their current shareholders.
The latter option will put some pressure on the share price, and that is why companies more often choose to buyback shares.
I think that this is a good thing for shareholders. By buying back shares the company is effectively reducing its outstanding shares on the market. And if there are fewer shares outstanding the EPS (Earning Per Share) will be affected by this action. Normally when a company announces a share buyback, investors get excited and the share price will also go up.
In my humble opinion, these are good things for shareholders.
Of course there are also some downsides to buybacks. A share buyback has effect on a company’s income statement because it reduces its outstanding share (duh..). But it also has some impact on other financial statements.
By buying back shares with left over cash, the company will lower its total asset base. By doing this the equity/debt ratio will shift. Due to this shift the company can be valued as more risky. And of course this will have an influence on the decisions investors make.
What is Mr. Buffett’s opinion?
In his 2011 letter to the shareholders of Berkshire Hathaway, Warren Buffett wrote:
“Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.”
Every time Berkshire Hathaway’s share price falls under a certain level, Warren Buffett said that he automatically picks up shares. When the share prices goes up again, BH can always reissue the shares. And by this BH makes some extra money (which the can put to good use again).
It is safe to say that under the right conditions, Mr Buffett loves buybacks.
And yes there are also a lot of other (so called) gurus that are against buybacks. A very commonly heart argument is that is a weakness of the board of directors. They can not choose to do the right thing for the growth of the company.
Luckily we live in a free world, where everybody can have its own opinion (and lets al work on it to keep it this way!!! Our freedom of speech, religion and the pursuit of happiness is under pressure the last couple of years).
When a company has announced a share buyback program, they must use some common sense executing the program. As an average investor I prefer to buy stocks when the valuation of the stock is low. I normally don’t buy stocks when they are highly priced by Mr. Market. This rule and principle must also apply for companies.
When a company’s stock is being highly valued by the market, buying back shares at those high valuations can lead to long-term shareholder capital destruction. And that is something nobody wants. When valuations are sound, or better yet, excessively low, the best investment opportunity a company may have is to invest in its own stock.
If a company executes its share buyback program like this, then in my opinion it is executed correctly.
I think that share buybacks, if preformed correctly, are good for shareholders. I love share buybacks.
“When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.” – Warren Buffett
What do you think of share buyback? I like to hear from you