Investors may remain cautious, company boards took advantage of December

Equity prices remain resilient as a combination of the Fed, trade and government shut down fears receding, has encouraged investors. Although evidence suggests investors were reluctant to take advantage of the weakness towards the end of 2018. It now appears some of the recovery may have been assisted by companies taking advantage of the weakness in share prices in December to accelerate share buyback programs according to a Barron’s article. For the first time company share buy backs totalled more than a trillion dollars in a year, 2018.

Part of the new appetite for buybacks would have been created by the capital repatriated as a result of the tax changes introduced by Trump. Companies can use, in theory profits, but often debt, particularly in the current low interest rate climate, to buy back their own shares. Company boards have several options when deciding how to distribute profits and manage their balance sheet to the most efficient way. Go on the acquisition trail, by acquiring in another company. This can be risky but can provide future growth and benefits from cost cutting. They can invest in the existing company, for example additional equipment or modernisation programs. Another option is to increase payments to shareholders, via dividends or special one-off payments. Alternatively they buy back shares of their own company. This can have the advantage of improving metrics related to the number of shares in issue, earnings per share as an example. One method analysts use to value a company. For this reason, it can be popular for company boards, as often reward packages can be linked to earnings metrics.

Some analysts view buyback schemes as financial engineering as the money is not actually returned to shareholders and as it can distort valuation metrics. It can have positive effects, not only on valuation, as it should suggest the management believe the true value of the shares is not being realised. Companies were not allowed to buy back their own shares before 1982, for some of the reasons we stated above. In particular as it reduces a company’s ability to invest in capital expenditure. Research work suggests that buyback programs do not create value for the shareholders.

What ever the rights and wrongs share buy backs will remain a part of many company’s dividend policy in the future.

Posted on February 15, 2019 .