Written by Ben Kumar, Head of Equity Strategy at 7IM
Last week, we talked about dividends as a way for companies to reward their shareholders. But that’s not the only way that companies can distribute their profits.
When a company is profitable, it can also choose to reward investors by buying some of their shares back (see end of email for the maths*). Companies buy some shares from investors, and then cancel them – just delete the shares from existence. The remaining shareholders end up owning more of the company – plus there’s usually a bump in the stock price from all of the buying.
Dividends are like Pringles. Once you pop, the fun don’t can’t stop. A company that STOPS paying dividends gets punished by the market.
But share buybacks aren’t viewed in the same way. For some bizarre reason, they’re usually viewed as a one-off, even if they happen all the time!
So lots of businesses choose to use buybacks – Wall Street in particular (it’s an American thing, like maple syrup on pancakes, or extremely old leaders…).
Already in the first week of February 2024, US companies announced $105bn of planned buybacks, and S&P 500 companies are expected to buy $885bn in stock this year.
The chart below shows just how much US CEOs prefer buybacks to dividends – especially since the mid-2000s.
Compare the stable blue dividend line to the jerky pink buybacks line. Much more flexible.
Source: S&P Dow Jones
Now in one sense, this is just a sensible response to repaying shareholders – who shouldn’t care too much as long as they end up with the same amount of money in the end.
But over the last few years, share buybacks have been attracting some bad press.
Because quite a number of CEOs tend to be paid/rewarded with shares in the business they’re running – usually in the form of options (which don’t pay dividends).
So – the theory goes – there’s a misalignment of incentives.
A CEO might prefer to progress buybacks than pay dividends, so that the share price rises in short order.
Even worse, a particularly poor CEO might prefer to progress buybacks rather than invest in the business!
Source: Shutterstock/Retail Photographer
Bed Bath & Beyond is a homeware seller in the US. It’s like Dunelm here in the UK.
In the three years following Covid, Bed Bath and Beyond consistently made losses and racked up debts.
But also in the three years following Covid, it bought back $836 million of its own shares.
During that period, its CEO was paid $47 million… only 7% of which was basic salary. That CEO left in 2022.
In 2023, Bed Bath and Beyond declared bankruptcy…
Buybacks need to be done for the right reasons. They can be exciting for shareholders in the short term, but can quickly become the source of long-term disappointment if done irresponsibly.
