Share buybacks rise in the UK – what effect will it have?

Share buybacks used to be rare in the UK, but are now gaining popularity. That's good news for investors

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Companies have three different ways of using profit or excess capital generated from the business. The first is reinvesting money into the company if the potential return on invested capital is attractive. This will vary from firm to firm and ultimately depend on the overall cost of capital. If the cost of capital is higher than the potential return on invested capital, it does not make sense to reinvest back into the business. Instead, the company should consider the second method of using excess money: debt repayment.

If a company calculates that an expansion project will only generate a 10% return on invested capital, but its outstanding debt has an interest rate of 12%, using the available capital to reduce borrowing would make more sense. If a company cannot find any good expansion opportunities (including mergers) and has a relatively low level and cost of borrowing, then it can turn to a third option – returning cash to investors. Two of the most common ways to return capital are dividends and share repurchases. Both accomplish the same goal of returning capital, but each approach has different benefits and drawbacks.

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Rupert Hargreaves
Contributor and former deputy digital editor of MoneyWeek

Rupert is the former deputy digital editor of MoneyWeek. He's an active investor and has always been fascinated by the world of business and investing. His style has been heavily influenced by US investors Warren Buffett and Philip Carret. He is always looking for high-quality growth opportunities trading at a reasonable price, preferring cash generative businesses with strong balance sheets over blue-sky growth stocks.

Rupert has written for many UK and international publications including the Motley Fool, Gurufocus and ValueWalk, aimed at a range of readers; from the first timers to experienced high-net-worth individuals. Rupert has also founded and managed several businesses, including the New York-based hedge fund newsletter, Hidden Value Stocks. He has written over 20 ebooks and appeared as an expert commentator on the BBC World Service.