How best to return cash to shareholders?

[Dod101]

If the company instead buys back shares to the value of the dividend, the money again disappears from the company's balance sheet, and the company is worth less: exactly what it would have been if it had paid out a dividend. There are now, however, less shares in issue. Again, no money has been created and destroyed. The value of an investor's shareholding is worth exactly what it was before the buy back. He is neither richer nor poorer, but the money has disappeared from the company balance sheet, as it would do if a dividend had been paid.

If a company cannot invest money to generate at least the same return as the market, it should return money to shareholders. That does not always happen, however. I would much rather have buy backs than dividends, because I do not have to pay tax on them.

The position is better stated as fewer shares than less shares, but the substantive point is that the investor's shareholding (assuming he has not participated in the buyback) is no longer worth exactly what it was before the buy back. It is now worth rather more than it was before the buyback. It may not be reflected immediately (or ever) in the share price but the fact is that he has now got a larger economic stake in the company than he had before.

Yes, his shareholding is worth exactly what it was before the buy back. (Actually, there will be some costs in executing the buy back, and there will also be share price volatility, but that is just confusing matters.) The company is worth less after the buy back, because it no longer has the money that it spent on the buy back. (Look at the accounts.) On the other hand, there are now less shares in issue, so an investor owns a larger proportion of the company than he did before the buy back. The two factors cancel each other out. Your share holding is worth what it was before. You do not get to have your cake and eat it.

As scrumpyjack has pointed out a situation where your statement is not correct. Another is of course if the directors buy the shares at less than NAV, because that will increase the NAV per share for the continuing shareholders.

Dod

[scrumpyjack]

Following on from Dod101's comment, Aviva's solvency II net asset value is 442p so buybacks at less than that (current SP 405p) will also be good for shareholders by increasing NAV. (and that was the 2020 figure so NAV is probably higher by now)

[GeoffF100]

The position is better stated as fewer shares than less shares, but the substantive point is that the investor's shareholding (assuming he has not participated in the buyback) is no longer worth exactly what it was before the buy back. It is now worth rather more than it was before the buyback. It may not be reflected immediately (or ever) in the share price but the fact is that he has now got a larger economic stake in the company than he had before.

Yes, his shareholding is worth exactly what it was before the buy back. (Actually, there will be some costs in executing the buy back, and there will also be share price volatility, but that is just confusing matters.) The company is worth less after the buy back, because it no longer has the money that it spent on the buy back. (Look at the accounts.) On the other hand, there are now less shares in issue, so an investor owns a larger proportion of the company than he did before the buy back. The two factors cancel each other out. Your share holding is worth what it was before. You do not get to have your cake and eat it.

That is not necessarily the case, because it is only valid if the cash is of equal value in or out of the company. Take Aviva, where business disposals mean they have at least £4 billion of cash sitting in the business for which they do not have a use that will make an adequate return. So either they get 1% or 2% interest on it or they buy back shares which 'return' about 11% in eps or 5% in dividends. They are not going to get that return on cash so it is hugely better for shareholders that they buy back shares at about 405p and that 20p in dividends / 45p in eps can be spread over the remaining shares, as compared with the negative real return on cash. Overwhelmingly shareholders are better off with the cash NOT being in the business.

Absolutely. As I said: "If a company cannot invest money to generate at least the same return as the market, it should return money to shareholders." Nonetheless, the buy back does not immediately create value. Conservation of money is the easiest way to see what is going on, but some simple algebra shows more explicity what is going on.

Let c be the market cap of the company and n be the number of shares in issue.

The share price is then c/n

The company buys back m shares at a cost of m*c/n

There are now n - m shares in issue and company is worth c - m*c/n

The share price is now (c - m*c/n) / (n - m) = (c*n - m*c) / (n*(n - m)) = c/n

The share price is unchanged.

[doug2500]

.....but future increases in profitability will be spread between fewer shares so it should amplify increases in eps which if the multiple remains constant should mean a larger increase in share price than would otherwise be the case?

For me buybacks are good when the shares are undervalued e.g. Somero right now (IMO) but poor when shares are fully or even overvalued which is too often the case. They seldom happen when shares are truly undervalued e.g. march 20 and numerous times since, but often when everything is settled, calm and expensive again.

[Bouleversee]

So who would want to sell their shares? If nobody does, the buybacks can't happen.

[scrumpyjack]

So who would want to sell their shares? If nobody does, the buybacks can't happen.

Well it's a question of price and the differing views of investors. The balance between buyers and sellers is what results in the current share price and FTSE100 companies are large enough that there will always be buyers and sellers. The company can set parameters for planned buybacks, eg not more than x% of the daily traded volume can be bought or the maximum price at which they will buy. An investment bank will then carry out the buy back over a period of time in accordance with the instructions from the company. There are I think very different views about Aviva with some seeing it as a serial value destroyer whose dividend is still only half what it was 20 years ago (and SP one third!), whilst others think 'this time it's different, the CEO is sorting it out'. It takes two views to make a market, as the old saying goes.

[GeoffF100]

.....but future increases in profitability will be spread between fewer shares so it should amplify increases in eps which if the multiple remains constant should mean a larger increase in share price than would otherwise be the case?

For me buybacks are good when the shares are undervalued e.g. Somero right now (IMO) but poor when shares are fully or even overvalued which is too often the case. They seldom happen when shares are truly undervalued e.g. march 20 and numerous times since, but often when everything is settled, calm and expensive again.

After a buy back, the company could do a share spit so that the number of shares in issue was same as it was before the buy back. The share price would then be the same as it would have been after paying a dividend rather than buying back shares. (With the same assumptions as before.) The only difference then would be that the share holdings would be concentrated in fewer hands. So, no, paying a dividend and executing a buy back are equivalent. (Except for taxes and costs, as already mentioned.)

Who is to say whether a company is overvalued? Some people think that a company's management believes that the company is undervalued because they are buying back shares. That does not make any more sense than thinking a company's management believes that the company is undervalued because they pay a special dividend. Of course, if the company's profits are more than expected, the share price is likely to go up, but that is another matter.

[GeoffF100]

After a buy back, the company could do a share spit so that the number of shares in issue was same as it was before the buy back. The share price would then be the same as it would have been after paying a dividend rather than buying back shares. (With the same assumptions as before.) The only difference then would be that the share holdings would be concentrated in fewer hands. So, no, paying a dividend and executing a buy back are equivalent. (Except for taxes and costs, as already mentioned.)

After the share split, your dividend will have been paid in the form of additional shares.

[Dod101]

Following on from Dod101's comment, Aviva's solvency II net asset value is 442p so buybacks at less than that (current SP 405p) will also be good for shareholders by increasing NAV. (and that was the 2020 figure so NAV is probably higher by now)

Of course NAV for a trading company is rather harder to value than for an investment trust say, because often there will be an element of goodwill and other intangibles whose value is more subjective than valuing 'hard' assets, but I think those arguing against buybacks are not always correct for the reasons that scrumpyjack and I have cited. Very difficult to use a slide rule and prove it one way or the other but I have no objection to share buybacks if the price paid is less than the directors honestly believe to be a true value of the shares.

Dod

[dealtn]

Yes, his shareholding is worth exactly what it was before the buy back. (Actually, there will be some costs in executing the buy back, and there will also be share price volatility, but that is just confusing matters.) The company is worth less after the buy back, because it no longer has the money that it spent on the buy back. (Look at the accounts.) On the other hand, there are now less shares in issue, so an investor owns a larger proportion of the company than he did before the buy back. The two factors cancel each other out. Your share holding is worth what it was before. You do not get to have your cake and eat it.

That is not necessarily the case, because it is only valid if the cash is of equal value in or out of the company. Take Aviva, where business disposals mean they have at least £4 billion of cash sitting in the business for which they do not have a use that will make an adequate return. So either they get 1% or 2% interest on it or they buy back shares which 'return' about 11% in eps or 5% in dividends. They are not going to get that return on cash so it is hugely better for shareholders that they buy back shares at about 405p and that 20p in dividends / 45p in eps can be spread over the remaining shares, as compared with the negative real return on cash. Overwhelmingly shareholders are better off with the cash NOT being in the business.

Absolutely. As I said: "If a company cannot invest money to generate at least the same return as the market, it should return money to shareholders." Nonetheless, the buy back does not immediately create value. Conservation of money is the easiest way to see what is going on, but some simple algebra shows more explicity what is going on.

Let c be the market cap of the company and n be the number of shares in issue.

The share price is then c/n

The company buys back m shares at a cost of m*c/n

There are now n - m shares in issue and company is worth c - m*c/n

The share price is now (c - m*c/n) / (n - m) = (c*n - m*c) / (n*(n - m)) = c/n

The share price is unchanged.

Which is higher than if a dividend had been paid, which some appear to believe isn't the case, claiming buybacks don't assist the share price.

[Newroad]

Hi All.

I don't in general have a horse in this race, as discussed to this point - most of my investments are tax sheltered in ISA's or SIPP's. My guess is that a priori, it makes no immediate difference whether cash is "returned" via buyback or dividend.

However, the arguments thus far have (rightly) focused on tax events, execution costs (for the company) and general ease of admin. There is another angle though - derivatives and similar. I haven't entirely thought this through, but consider for example the relative positions of

The person who holds the underlying shares, vs
The person who holds at (or near) the money call options on the shares

A share buyback would appear to largely or wholly help the call option holder, whereas a dividend would appear to help the underlying shareholder.

This would appear to be a big consideration in the US (where options are more common than CFD's and similar - though these may exhibit similar considerations - as alluded to above, I haven't thought it fully through yet) and a partial consideration in the UK for that part of the market where it's relevant. In context, I would slightly prefer dividends to share buybacks, all things being equal. It also has the slight personal advantage of contributing to my regular rebalancing of the portfolio. Not a big issue though.

The final point is that is must be possible (and I think I've seen this done in Australia at least) to semi-simultaneously return capital in multiple ways - e.g.* a special dividend which can optionally be reinvested in newly minted shares, or something like that. In the real world, despite the marginally increased execution costs, this is likely to cover the most important consideration for people with different interests - tax events.

Regards, Newroad

* I'm not sure if it was exactly like this, but you probably get the gist

[csearle]

Also if you get the dividends you simply get the money whereas if you get a share buyback you get a humongous discussion as to why you really have still got the money really whilst not apparently having it. C.

[GeoffF100]

That is not necessarily the case, because it is only valid if the cash is of equal value in or out of the company. Take Aviva, where business disposals mean they have at least £4 billion of cash sitting in the business for which they do not have a use that will make an adequate return. So either they get 1% or 2% interest on it or they buy back shares which 'return' about 11% in eps or 5% in dividends. They are not going to get that return on cash so it is hugely better for shareholders that they buy back shares at about 405p and that 20p in dividends / 45p in eps can be spread over the remaining shares, as compared with the negative real return on cash. Overwhelmingly shareholders are better off with the cash NOT being in the business.

Absolutely. As I said: "If a company cannot invest money to generate at least the same return as the market, it should return money to shareholders." Nonetheless, the buy back does not immediately create value. Conservation of money is the easiest way to see what is going on, but some simple algebra shows more explicitly what is going on.

Let c be the market cap of the company and n be the number of shares in issue.

The share price is then c/n

The company buys back m shares at a cost of m*c/n

There are now n - m shares in issue and company is worth c - m*c/n

The share price is now (c - m*c/n) / (n - m) = (c*n - m*c) / (n*(n - m)) = c/n

The share price is unchanged.

Which is higher than if a dividend had been paid, which some appear to believe isn't the case, claiming buybacks don't assist the share price.

Buying back shares assists the share price relative to what it would have been if a cash dividend had been paid instead, but not in absolute terms.

[GoSeigen]

So who would want to sell their shares? If nobody does, the buybacks can't happen.

You do know what stock exchanges are for??? If no-one is trading or wants to trade on the exchange, delist!

Moderator Message:
Any chance of moderating the sarcasm please? Thanks - Chris

GS

[TheMotorcycleBoy]

and they say:

"We are increasing our share buyback to £1 billion1 as part of our commitment to return at least £4 billion to ordinary shareholders. We will update further on our capital return and dividend plans at our full year results in March 2022."

So we may be in line for a special dividend (and share consolidation?) next year.

I would far prefer them just to give the money to we shareholders, rather than pratt about with share buybacks. If they wish to reduce the share capital, have a tender offer.

TJH

Disingenuous. They are returning the money to us shareholders.

I've disagreed with you before on this, and I'm disagreeing with you now. They are not returning money per se, they are merely spending their money on something which we as shareholders happen to also own.

Unless one sees a tangible gain in one's holdings, I claim zero money has returned. Take ULVR who embarked on a share purchase scheme from 3/21 - 12/21. It didn't shift their SP one iota. Where as the overall market did shift in a positive direction over the same timeframe.



compared to



there's no way you can they have returned cash to me. I'll state again, they've just spent some money on something. Whether we see the future EPS for the stock rise, and ULVR then announce a commensurate rise in DPS, then we'd see cash returned. That's for the future to decide.

Matt

[TheMotorcycleBoy]

From my discussions / research share buybacks are most beneficial to HNWIs i.e. people don't like having to pay extra income tax.

I don't really think that means that they are "the best way". For one, if firms couldn't return money in this way, they'd be forced, I think, to utilise this cash by either

1. lending it to a bank, which would lower rates, and help small business acquire capital
2. invest in growth and hence jobs
3. pay dividends which would generate tax revenue

what distinguishes the above 3 points (from BBs) is that more money is passed to the economy (i.e. to poorer people who spend on goods) on the whole. This is arguably a very good thing even for HNWIs since a lot of the firms in which they are invested in will benefit from increased sales and profits.

Seems quite possible that folk preferring BBs are aiming a shot at their future feet.

Matt

[scrumpyjack]

I was pleased to see that the press expect the rest of the Aviva capital return to be done by share buybacks (another 3bn).

It is quite a simple principle - return capital as capital and profit as dividends.

As Aviva have disposed of lots of businesses they wish to reduce the number of shares to reflect that, very sensible and far better than blowing it on a directors ego trip or declaring it as a dividend when it is capital not income.

If you want cash back, simply sell some of your shares back to the market.

[dealtn]

From my discussions / research share buybacks are most beneficial to HNWIs i.e. people don't like having to pay extra income tax.

I don't really think that means that they are "the best way". For one, if firms couldn't return money in this way, they'd be forced, I think, to utilise this cash by either

1. lending it to a bank, which would lower rates, and help small business acquire capital
2. invest in growth and hence jobs
3. pay dividends which would generate tax revenue

what distinguishes the above 3 points (from BBs) is that more money is passed to the economy (i.e. to poorer people who spend on goods) on the whole. This is arguably a very good thing even for HNWIs since a lot of the firms in which they are invested in will benefit from increased sales and profits.

Seems quite possible that folk preferring BBs are aiming a shot at their future feet.

Matt

What do you think happens to the cash exchanged as part of a buy back? How is it different? Do the recipients of that cash not 1) lend it to a bank? Or 2) Invest it in growth and create jobs? Or maybe 3) Provide it as recycled capital that can be used by companies to pay dividends or create tax revenues?

Transmission mechanisms are similar, and whilst marginal differences exist due to taxes, and foreign ownership and other international factors, the impact on the economy will be broadly similar.

I guess you will just never be convinced that money is fungible and macro and micro differences aren't that great in theory, and perhaps practice.

[TheMotorcycleBoy]

From my discussions / research share buybacks are most beneficial to HNWIs i.e. people don't like having to pay extra income tax.

I don't really think that means that they are "the best way". For one, if firms couldn't return money in this way, they'd be forced, I think, to utilise this cash by either

1. lending it to a bank, which would lower rates, and help small business acquire capital
2. invest in growth and hence jobs
3. pay dividends which would generate tax revenue

what distinguishes the above 3 points (from BBs) is that more money is passed to the economy (i.e. to poorer people who spend on goods) on the whole. This is arguably a very good thing even for HNWIs since a lot of the firms in which they are invested in will benefit from increased sales and profits.

Seems quite possible that folk preferring BBs are aiming a shot at their future feet.

Matt

What do you think happens to the cash exchanged as part of a buy back? How is it different? Do the recipients of that cash not 1) lend it to a bank? Or 2) Invest it in growth and create jobs? Or maybe 3) Provide it as recycled capital that can be used by companies to pay dividends or create tax revenues?

I don't know dealtn. But presumably a smaller amount, than would be the case with dividends, is delivered to governments world wide in the form of income tax to finance public spending.

I guess you will just never be convinced that money is fungible and macro and micro differences aren't that great in theory, and perhaps practice.

And I'm not convinced that this last one of yours is particularly relevant in this debate

Matt

[TheMotorcycleBoy]

I was pleased to see that the press expect the rest of the Aviva capital return to be done by share buybacks (another 3bn).

It is quite a simple principle - return capital as capital and profit as dividends.

As Aviva have disposed of lots of businesses they wish to reduce the number of shares to reflect that, very sensible and far better than blowing it on a directors ego trip or declaring it as a dividend when it is capital not income.

If you want cash back, simply sell some of your shares back to the market.

Incidentally how much free cash do Aviva actually have?

What I find bizarre is that firms like ULVR embellish BBs as "returning cash to shareholders" when they are actually heavily in debt. I would add that I do hold share in Microsoft, who do BBs, but at least they have a positive net cash balance. That's real cash.

But regardless my belief is that BBs are a tax fiddle. Arguably why some governments are trying to "discourage" them.

https://www.nytimes.com/2021/11/19/busi ... stock.html

Matt