Companies around the world make important decisions every day. Some companies have cash flow issues, but some lucky companies have the opposite problem. i.e. they have extra cash on their hands. The question is: what should they do with that cash? Some companies choose to invest in the business, some companies buy other companies, other companies employ a generous dividend paying policy and lastly, others pursue a share buyback programme. This is a mechanism used by a company to literally “buy back” or repurchase their company shares. The logistics vary, and the company can purchase the shares on the market or go to the shareholders directly, depending on what is more convenient.
There are several reasons that a company would wish to repurchase their shares. One of which is that they consider their shares to be undervalued. Management may be optimistic about the future as they may have good projects in the pipeline. However, the market may be punishing them for recent negative results and as a result, the company may be unsuccessful in convincing the market to invest in their stock. In pursuing a buyback programme, it is a signal to the market that they have confidence in their company, and it provides support for the stock price.
No Growth Opportunities
The second reason a company may pursue a buyback programme is that they are unable to deploy the cash they have into any business ventures, i.e. they may not see any attractive growth opportunities, so they decide that it is better to give the cash back to the shareholders. This is especially the case for mature companies. In addition, if the company is based in a country that has a high tax rate on dividends and it is cheaper for the shareholder to accept the cash via a share buyback, then the choice is obvious.
Boost Financial Ratios
There is a third reason that management may pursue this buyback option, and this is to boost their financial ratios. Without getting too technical, as we know with mathematics, if you reduce the denominator, you will increase the ratio. Therefore a buyback increases the earnings per share ratio (you have less shares, earnings stay the same) and simultaneously decreases the price to earnings (P/E) ratio (the earnings per share increases, assumes the price stays the same). All things being equal, investors find a lower P/E ratio more attractive. This can benefit executives who are compensated through stock options, are evaluated on specific metrics and benefit when their stock price goes up. The return on equity (ROE) and return on asset (ROA) ratios also benefit (increase).
The Local Experience
In the last few years, Jamaicans have been far more accustomed to companies raising money by way of IPO’s, APO’s, Rights Issues, Preference Shares and the list goes on. There are only a few local companies who have used this tool of returning cash to shareholders. Unlike Jamaica, this is very commonplace in the U.S. where it is reported that in 2019 alone, stock buybacks totaled US$730 billion.
The most recent announcement was made by Sagicor Financial -the parent company of Sagicor Group-on June 17th, 2020, that they will be commencing a share buyback programme to repurchase 3,000,000 of the common shares of the company. These will be made on the open market over the course of one year. Similarly, in the last two years, Eppley Caribbean and Kingston Properties have conducted share buyback programmes.
Lastly, if a company plans to go private, a buyback may be the first signal to the market that they are pursuing this direction. Buybacks normally provide a temporary boost for the share price. As with everything, you have big proponents and large opponents (who fear that it can be used to manipulate the stock price). However, at the end of the day it is one of the tools available to companies to deploy cash, send signals to the market and to improve their metrics. Happy Investing!
Yanique Leiba-Ebanks, CFA, FRM is the AVP, Pensions & Portfolio Investments at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: [email protected]