What is a share buyback?

A share buyback means just what it says – a company buys back its own shares. But why? And how does that benefit shareholders?

There are two main ways for companies to return cash to shareholders. 

Dividends tend to be preferred by income investors; a dividend is a cash payout to shareholders, typically issued on a half-yearly basis. 

The other method is to use a share buyback. This means just what it says – the company buys back its own shares. 

It’s easy to see why shareholders like dividend payouts. But how do buybacks benefit shareholders? Well, when a company buys and cancels some of its own shares, the remaining shareholders are left holding a greater proportion of the company. 

Let’s say a firm has one million shares in issue, and the share price is £10 per share.  It made one million pounds profit last year. So it has earnings per share of £1. 

Let’s say it wants to return the whole one million pounds profit to its shareholders via a share buyback. It buys back 100,000 shares at £10 a share and cancels them. This leaves 900,000 shares in issue. 

That means earnings per share has increased from £1 to just over £1.11, because there are now fewer shares. In turn, assuming that investors keep valuing its earnings on a constant basis, the share price would rise to just over £11.

Fans of buybacks argue that they are more tax-efficient than dividends. For managers, buybacks are also more flexible than dividend payments. Shareholders tend to react more negatively to a dividend cut than to a reduction in buyback levels.

Critics argue that executives have an incentive to use buybacks to meet performance targets linked to share-price growth. So they may curb investment or borrow too much to fund buybacks. 

Timing can also be a problem. Some studies suggest that larger companies in particular have a bad habit of buying back shares near the top of the market, when they’re expensive, rather than nearer the bottom, when they’re cheap.

Recommended

When will interest rates go up?
UK Economy

When will interest rates go up?

New interest rates will be announced this month – we look at whether they will go up and what the impact will be.
5 Dec 2022
Heated airer vs tumble dryer – which is cheaper?
Personal finance

Heated airer vs tumble dryer – which is cheaper?

What is the most cost effective way to dry your clothes – a heated airer or a tumble dryer? We compare the costs.
5 Dec 2022
Best savings accounts – December 2022
Savings

Best savings accounts – December 2022

Interest rates on cash savings are making a comeback. We look at the best savings accounts on the market now
5 Dec 2022
Scottish Mortgage managers reassure investors about its recent poor performance
Investment trusts

Scottish Mortgage managers reassure investors about its recent poor performance

After a spectacular couple of decades, the Scottish Mortgage Investment Trust has fallen by 40% this year. As its managers address shareholder concern…
5 Dec 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Radiator vs electric heater – which is cheaper?
Personal finance

Radiator vs electric heater – which is cheaper?

We compare the costs, pros and cons of radiators and electric heaters and see which one will help keep your energy bill as low as possible.
28 Nov 2022
State pension errors – why tens of thousands of mothers could be missing out on millions in state pension payments
State pensions

State pension errors – why tens of thousands of mothers could be missing out on millions in state pension payments

LCP launches Mothers Missing Millions campaign amid DWP state pension errors.
3 Dec 2022