The Lemon Fool

I started moaning about share buybacks over at the ULVR thread. I still have my reservations about ULVR's current buyback campaign, but certainly in the context of ULVR I've already stated them there.

Alaric wrote:

TheMotorcycleBoy wrote:Despite all of your previous replies, I stand by my earlier conviction, that share buybacks are mainly to advantage of large financial institutions and are of significantly less benefit, compared to dividends, for small time investors like me, and zero benefit to wider society due to income tax avoidance.

Doesn't that miss the point that "large financial Institutions" include those managing investments on behalf of charities, pension funds, ISA and SIPP holders? For them there's no income tax to avoid and that even includes small investors with less than £ 2,000 a year in dividends. Dividends, notionally at least, come from profits already subject to taxation in the form of non-reclaimable Corporation Tax.

Thanks Alaric,

Another concern of mine regards buybacks, is that surely if they year-on-year, more than mop up the dilution caused by employee stock awards, then I assume that the policy of "returning capital to the shareholders" using buybacks is unsustainable. Won't a point eventually be reached where there is no more stock to buy back, or won't a point be reached where a legal minimum of stock (if such a limit exists) left in the market is reached? I accept that that time maybe far away, but given many public companies' penchant for buybacks it seems like a reasonable enough query.

thanks Matt

TheMotorcycleBoy wrote:Another concern of mine regards buybacks, is that surely if they year-on-year, more than mop up the dilution caused by employee stock awards, then I assume that the policy of "returning capital to the shareholders" using buybacks is unsustainable. Won't a point eventually be reached where there is no more stock to buy back, or won't a point be reached where a legal minimum of stock (if such a limit exists) left in the market is reached? I accept that that time maybe far away, but given many public companies' penchant for buybacks it seems like a reasonable enough query.

thanks Matt

No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.


GS

I am firmly of the view that share buybacks should be via a tender offer to all shareholders, rather than on the open market. That way, shareholders have the option of disposing of some or all of their shares, or of keeping their holding intact.

The option of returning capital to shareholders via a special dividend, followed by a share consolidation, is compulsory, whereas the tender offer is voluntary and avoids the need to buy back the shares lost in the consolidation.

TJH

Boeing had several share buy-backs before two aircraft crashed and they had to go begging for horrendous amounts of money.

Share buy backs are, in my opinion, a manipulative tool, for poor management, that has no vision and no understanding of the long term goals of the business.

AiY

tjh290633 wrote:I am firmly of the view that share buybacks should be via a tender offer to all shareholders, rather than on the open market. That way, shareholders have the option of disposing of some or all of their shares, or of keeping their holding intact.

How exactly is a buyback on the open market preventing any shareholder having "the option of disposing of some or all of their shares, or of keeping their holding intact."?

The method you are against provides exactly what you want.

dealtn wrote:

tjh290633 wrote:I am firmly of the view that share buybacks should be via a tender offer to all shareholders, rather than on the open market. That way, shareholders have the option of disposing of some or all of their shares, or of keeping their holding intact.

How exactly is a buyback on the open market preventing any shareholder having "the option of disposing of some or all of their shares, or of keeping their holding intact."?

The method you are against provides exactly what you want.

I was thinking more of the "Return of capital" aspect. In that case a Tender Offer is a better route than a special dividend. Buybacks are the same but on a smaller scale, but are spread over a longer timescale, to avoid frightening the horses and involve fees paid to a third party. Often similar in magnitude to the dividend payment, they only benefit those whose remuneration is related to share price. Higher dividends would have the same effect at lower cost.

TJH

tjh290633 wrote:.....they only benefit those whose remuneration is related to share price.

Oooh, that's very cynical. You can't really think that

V8

88V8 wrote:

tjh290633 wrote:.....they only benefit those whose remuneration is related to share price.

Oooh, that's very cynical. You can't really think that

V8

He's not the only one

GoSeigen wrote:

TheMotorcycleBoy wrote:Another concern of mine regards buybacks, is that surely if they year-on-year, more than mop up the dilution caused by employee stock awards, then I assume that the policy of "returning capital to the shareholders" using buybacks is unsustainable. Won't a point eventually be reached where there is no more stock to buy back, or won't a point be reached where a legal minimum of stock (if such a limit exists) left in the market is reached? I accept that that time maybe far away, but given many public companies' penchant for buybacks it seems like a reasonable enough query.

thanks Matt

No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.


GS

I'm not quite clear about what you are saying here GS. I'll be more direct. Is it possible for a company to execute numerous campaigns of buybacks such that ultimately the company has only one single share outstanding and available for transaction in the market place?

Matt

TheMotorcycleBoy wrote:

GoSeigen wrote:

TheMotorcycleBoy wrote:Another concern of mine regards buybacks, is that surely if they year-on-year, more than mop up the dilution caused by employee stock awards, then I assume that the policy of "returning capital to the shareholders" using buybacks is unsustainable. Won't a point eventually be reached where there is no more stock to buy back, or won't a point be reached where a legal minimum of stock (if such a limit exists) left in the market is reached? I accept that that time maybe far away, but given many public companies' penchant for buybacks it seems like a reasonable enough query.

thanks Matt

No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.


GS

I'm not quite clear about what you are saying here GS. I'll be more direct. Is it possible for a company to execute numerous campaigns of buybacks such that ultimately the company has only one single share outstanding and available for transaction in the market place?

Matt

In theory yes. But so what, any buyer could effectively do the same thing. It would drive the price up through successive prices such that those happy to sell would do so. By implication those that have sold are happy and so are those who haven't.

What's your issue with it, theoretically, or practically?

dealtn wrote:

TheMotorcycleBoy wrote:

GoSeigen wrote:
No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.


GS

I'm not quite clear about what you are saying here GS. I'll be more direct. Is it possible for a company to execute numerous campaigns of buybacks such that ultimately the company has only one single share outstanding and available for transaction in the market place?

Matt

In theory yes. But so what, any buyer could effectively do the same thing. It would drive the price up through successive prices such that those happy to sell would do so. By implication those that have sold are happy and so are those who haven't.

What's your issue with it, theoretically, or practically?

I didn't say I had an issue.

I merely alluded to the possibility that its unsustainable as a mechanism of benefitting the shareholders. From what you are saying above, indeed it is. Eventually a firm will run out of shares to BB. Whereas a firm can continue to pay divs for as long as it's making a profit.

Matt

TheMotorcycleBoy wrote:

dealtn wrote:

TheMotorcycleBoy wrote:I'm not quite clear about what you are saying here GS. I'll be more direct. Is it possible for a company to execute numerous campaigns of buybacks such that ultimately the company has only one single share outstanding and available for transaction in the market place?

Matt

In theory yes. But so what, any buyer could effectively do the same thing. It would drive the price up through successive prices such that those happy to sell would do so. By implication those that have sold are happy and so are those who haven't.

What's your issue with it, theoretically, or practically?

I didn't say I had an issue.

I merely alluded to the possibility that its unsustainable. From what you are saying above, indeed it is. Eventually a firm will run out of shares to BB. Whereas a firm can continue to pay divs for as long as it's making a profit.

Matt

So what. Firstly I disagree about dividends being paid out of profit. But regardless they can pay a dividend, or buy back shares. They can create new shares, they can take themselves private. Shareholders can vote with their feet/wallets on all those decisions, or at AGMs.

I really don't see the relevance.

dealtn wrote:

TheMotorcycleBoy wrote:

dealtn wrote:
In theory yes. But so what, any buyer could effectively do the same thing. It would drive the price up through successive prices such that those happy to sell would do so. By implication those that have sold are happy and so are those who haven't.

What's your issue with it, theoretically, or practically?

I didn't say I had an issue.

I merely alluded to the possibility that its unsustainable. From what you are saying above, indeed it is. Eventually a firm will run out of shares to BB. Whereas a firm can continue to pay divs for as long as it's making a profit.

Matt

So what. Firstly I disagree about dividends being paid out of profit. But regardless they can pay a dividend, or buy back shares. They can create new shares, they can take themselves private. Shareholders can vote with their feet/wallets on all those decisions, or at AGMs.

I really don't see the relevance.

If having one share is the problem then split the shares! Happens all the time.

https://en.wikipedia.org/wiki/Stock_split

GS

GoSeigen wrote:No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.

Apologies GS,

Don't worry I already knew about stock-splits! So on that note, I can convince myself that there are some similarities between buybacks and divs. However I also note that buybacks can be used by firms for different motives:

1. returning cash to shareholders (interchangeable with divs according to some)
2. reducing the firm's capital which without an equivalent increase in ROC implies the firm in question is entering a non-growth period
3. reducing cash/debt ratio, changing capital structure, either to convert cheap debt into higher yield dividend returns or reduce firms attractiveness for takeover

To be honest I'm sadly convinced that in ULVR's case their motivation is probably summed up best by 2. or 3. However I'm currently more interested in discussing option 1. since although it's apparent that this is not ULVR's current motivation, it intrigues me more since many firms describe their BBs in a very positive way (as a returning cash, a dividend substitute), and the sustainability of such technique initially seemed questionable to me. But of course now I can accept that you are right, i.e. with stock-splits the firm may potentially always be able to increase the number of shares issued in circulation, and hence can continue to BB forever. Okay - unsustainability claim quashed.

Now that I've proved to myself to that a firm can choose to BB forever, what about shareholder value? So hypothetically a firm can buyback 50% of their stock, as a cash returning vehicle, if they are high quality firm. Then what? Well the consequence of the 50% BB is a doubling of EPS (good news for execs) and the doubling of earnings yield. We then wait for the share price to double, and when it does I sell, make a 100% profit on my shares, then the firm issue a 2-to-1 stock split, and the SP halves, I buy the same quantity of shares back. This all sounds great but in the real world I'm at the whims of the market place to rerate the shares which in a world of uncertainty may never happen, and even it does I have to time the market correctly to benefit from the dividend-equivalence suggestion. As far as I'm concerned this is clearly a-bird-in-hand decision for me favouring the instant cash dividend option, and unlike dividends; in both the initial buyback by the firm and when I sell/rebuy brokers make money on fees and spreads.

Given the only above it's very unclear to me why any shareholder would prefer the BB route over dividends, since there is more friction, uncertainty and redirection of the firms cash/profits away from them into the hands of financial institutions. In the real world however, it seems that the main reason the BB is preferred by some, is due to differential tax rates, i.e. CGT being 20% and income tax being 40% for higher rate payers. This seems to be incredibly at odds from a moral standpoint when considered against your earlier fungibility remark used used to counter my flawed unsustainability claim.

However, sustainability aside, firstly it seems very clear that share buybacks are a poor substitute for cash dividends in terms of certainty, secondly any advantages they may possess are enjoyed by a very small section of society; corporate execs, HNWIs and financial agents.

Matt

Companies cannot buyback their own shares for ever. They need approval from their own shareholders and more importantly they can only finance purchases of their own shares if they have distributable reserves to cover the purchases. Eventually they will run out of these. Not sure if there is an absolute limit in any one year but I think I read somewhere that they could buyback a maximum of 20/25% but cannot find a reference for that. I am sure someone can help.

Dod

Dod101 wrote:Companies cannot buyback their own shares for ever. They need approval from their own shareholders and more importantly they can only finance purchases of their own shares if they have distributable reserves to cover the purchases. Eventually they will run out of these. Not sure if there is an absolute limit in any one year but I think I read somewhere that they could buyback a maximum of 20/25% but cannot find a reference for that. I am sure someone can help.

Dod

They can Dod. They only need to split stock periodically, in order that the SP has a sane enough value for them to be traded, by holders who wish to do so, and generate enough surplus cash to both buy back the shares and continue to make future earnings which match or better those current. Essentially the theoritical value of the totality of their currently issued stock being approximated by

An arbitary constant x Number of shares issued x Earnings yield per share

so BBs are sustainable, but arguably sub-optimal compared to cash divs as cash-return-to-shareholders mechanism, for those who aren't corporate execs, financial sector employess or HNWIs, As I attempted to demonstrate here.

Matt

UPDATE:
Dod: I only stated that a publicly owned firm can buy back stock forever, based on my interpretation of what GoSeigen said

viewtopic.php?p=446702#p446702
viewtopic.php?p=445678#p445678

I certainly don't know Company law well enough to know for sure

Matt

TheMotorcycleBoy wrote:

GoSeigen wrote:No, that is no more true than if the company pays the same amount to shareholders in dividends year after year. The two are interchangeable AFAICS. Don't forget the number of shares and therefore their price are notional for all intents and purposes and can be adjusted at the whim of the shareholders.

Apologies GS,

Don't worry I already knew about stock-splits! So on that note, I can convince myself that there are some similarities between buybacks and divs. However I also note that buybacks can be used by firms for different motives:

1. returning cash to shareholders (interchangeable with divs according to some)
2. reducing the firm's capital which without an equivalent increase in ROC implies the firm in question is entering a non-growth period
3. reducing cash/debt ratio, changing capital structure, either to convert cheap debt into higher yield dividend returns or reduce firms attractiveness for takeover

Would it help to separate motivation from practical effects? The effect of a buyback is actually to return cash to shareholders, regardless of the motivation for the buyback; is there any debate about that?

To be honest I'm sadly convinced that in ULVR's case their motivation is probably summed up best by 2. or 3. However I'm currently more interested in discussing option 1. since although it's apparent that this is not ULVR's current motivation, it intrigues me more since many firms describe their BBs in a very positive way (as a returning cash, a dividend substitute), and the sustainability of such technique initially seemed questionable to me. But of course now I can accept that you are right, i.e. with stock-splits the firm may potentially always be able to increase the number of shares issued in circulation, and hence can continue to BB forever. Okay - unsustainability claim quashed.

Indeed, its sustainability depends on the company continuing to make profits, exactly the same as dividend payments.

Now that I've proved to myself to that a firm can choose to BB forever, what about shareholder value? So hypothetically a firm can buyback 50% of their stock, as a cash returning vehicle, if they are high quality firm. Then what? Well the consequence of the 50% BB is a doubling of EPS (good news for execs) and the doubling of earnings yield. We then wait for the share price to double, and when it does I sell, make a 100% profit on my shares, then the firm issue a 2-to-1 stock split, and the SP halves, I buy the same quantity of shares back. This all sounds great but in the real world I'm at the whims of the market place to rerate the shares which in a world of uncertainty may never happen, and even it does I have to time the market correctly to benefit from the dividend-equivalence suggestion. As far as I'm concerned this is clearly a-bird-in-hand decision for me favouring the instant cash dividend option, and unlike dividends; in both the initial buyback by the firm and when I sell/rebuy brokers make money on fees and spreads.

I think you've made it a bit more complicated there than necessary. As I've often said, it's simpler just to treat shareholders as a class. [Your individual behaviour has different properties to the behaviour of all the shareholders in aggregate.] When you look at the position of all the shareholders it instantly becomes clear that in purchasing (say) 5% of their shares the company has returned cash to them and reduced the total shares outstanding by 5%. Whether you as an individual choose at that time to participate in the disposal (by selling) is entirely your choice but your action will be offset by the actions of the remainder of the shareholders. [If you sell 1% then 4% of the other shareholders will also sell. If you hold then 5% of the other holders will sell].
If the company instead paid a dividend of 5% the same 5% of cash would be paid to the shareholders, but evenly to all of them.

Note, 5% is a generous payout rate under current conditions.

Also note, a buyback of 50% of the shares at a rate of 5% pa will take just over 13 years. I'm not sure this fact informed your thoughts above...

Given the only above it's very unclear to me why any shareholder would prefer the BB route over dividends, since there is more friction, uncertainty and redirection of the firms cash/profits away from them into the hands of financial institutions. In the real world however, it seems that the main reason the BB is preferred by some, is due to differential tax rates, i.e. CGT being 20% and income tax being 40% for higher rate payers. This seems to be incredibly at odds from a moral standpoint when considered against your earlier fungibility remark used used to counter my flawed unsustainability claim.

However, sustainability aside, firstly it seems very clear that share buybacks are a poor substitute for cash dividends in terms of certainty, secondly any advantages they may possess are enjoyed by a very small section of society; corporate execs, HNWIs and financial agents.

What about all those shareholders who want to dispose of their shares?

GS

TheMotorcycleBoy wrote:UPDATE:
Dod: I only stated that a publicly owned firm can buy back stock forever, based on my interpretation of what GoSeigen said

viewtopic.php?p=446702#p446702
viewtopic.php?p=445678#p445678

I certainly don't know Company law well enough to know for sure

Matt

It's true that legally shareholder approval is required; I think that is taken as a given in the current discussion. Likewise, it is assumed that the rate of buyback is commensurate with the earnings of the company in the same way that a dividend would be.

GS