• Many shareholders and companies benefit from buy-back programs
• Share buybacks are not always the best solution
If a company announces a share buyback program, this is initially well received on the stock market. After all, this speaks for the confidence of the company management in its own share certificate. Because for the money that corporations invest in buying their own shares, there is apparently no more attractive investment opportunity from the company’s point of view. Buy-back programs are particularly widespread in the US corporate market, and the stock market environment in recent years has provided a strong boost in this area. However, DAX giants and large European corporations have recently increasingly relied on this type of liquidity return to their shareholders. Many stock market experts see this step not only positively.
Share Buybacks: More Money for Shareholders
Share buybacks are decided for a variety of reasons. One of the reasons is to maintain the stock price. If companies buy back their own shares on the market and withdraw them, the share portfolio is reduced. This automatically leads to an increase in the share price – in favor of the existing shareholders. This is one of the most common reasons for stock buybacks, particularly in the United States, where top executive compensation is often linked to stock price performance.
The US bank JPMorgan has shown with calculations that the share price is rising as a result of a share buyback program: In the first year after the announcement of the program, the shares concerned rose 13 percent more than the benchmark index.
And there is another advantage for the company’s shareholders: after the withdrawal of treasury shares, the dividend yield for the remaining shareholders increases. On the other hand, those who part with their shares as part of a share buyback program can hope for a premium that the company pays on the current share price. Anyone who has already toyed with the idea of selling their shares can achieve a higher selling price.
The company basically has several options for dealing with the redeemed shares. They often destroy the confiscated shares. In other cases, the titles are issued to employees, for example as part of option programs. In this way, companies can retain skilled workers – an advantage for the company itself, but also indirectly for the shareholders, who can hope that a stable workforce will have a positive impact on business development.
In addition, the shares bought back from the market can also serve as “currency”, for example when the company is looking for suitable takeover targets. Instead of paying for an additional purchase in cash, you can pay for it in full or in part with your own shares.
A share buyback can also prevent you from becoming a takeover target yourself – namely when a potential takeover bidder buys shares in the market to acquire a significant stake in the company. In addition, companies with buy-back programs have a certain influence on the shareholder structure, the fewer shares that are freely traded or the more shares are in the hands of reliable major shareholders, the less likely it is that a potential buyer will be able to acquire the necessary majority of shares .
Share buybacks not without controversy
But regardless of the positive effects that a buyback of own shares can have for companies and shareholders, shareholder protection groups are not entirely positive about share buybacks. Such measures are quite controversial among many experts, and skepticism is at least appropriate on the part of shareholders when it comes to share buybacks.
Because the repatriation of excess capital in this way also means that there is apparently no worthwhile alternative investment for the company’s liquid funds. Against this background, the question at least arises as to whether management has any other forward-looking ideas for the company. After all, excess capital could also be invested in research and development to keep the company competitive, or to expand a possible lead over the competition. If management instead decides to distribute to shareholders instead of to operational development, this can be detrimental to the company in the medium to long term.
In addition, the money missing from the share buyback could also be missing elsewhere and possibly endanger the growth ambitions of the group. This, too, will probably only become noticeable in the medium to long term, but can then have decisive consequences for the competitive situation.
In addition, the company may not be able to fall back on a financial cushion in times of crisis, an experience that many corporations had to make in connection with the corona pandemic, when business suddenly collapsed massively. But not only an exceptional event like COVID-19 can bring business to a standstill, dependency on suppliers, a failure on the part of the customer or various other events could also bring the group into liquidity difficulties. If he has then invested his money in share buybacks, there may be serious losses that endanger business development.
Another possible danger: Many large corporations have financed their share buybacks with debt capital in recent years. The low interest rate environment made it cheaper for companies to raise fresh capital for their share buyback programs than to use existing cash. In the worst case, namely when business is not going smoothly, this can cause financial difficulties, because interest on loans has to be serviced. If the capital is then lacking, the company may be at risk.
Take a differentiated look at the pros and cons of share buybacks
Anyone who tenders their shares as part of a share buyback program has advantages at first glance, as they can take advantage of a possible premium on the share price. At the same time, however, investors lose the right to their dividend payment and also lose their voting rights and the opportunity to continue to participate in the development of the business and share price. Investors who sell their shares in connection with buy-back programs should ideally have already considered selling the shares beforehand. A re-entry into the value is usually more expensive than before.
Anyone who does not tender their shares in the meantime retains dividend and voting rights, but on the other hand cannot benefit from a possible premium and will do less well in terms of returns than sellers of the shares.
In addition, the share price usually rises after a share buyback program, but if the program was used exclusively to maintain the price, for example because a management bonus was linked to the success of the share, the prices can also fall again afterwards. In particular, if buybacks are intended to distract from possible business problems or if a third-party takeover that may be positive for the company is to be prevented in this way, existing shareholders may look the other way.
Editorial office finanzen.net
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