Thursday, October 25, 2012

Companies Buying Back Shares



It looks like share buybacks is back in the headlines again. My blogging life began officially in September 2005, and share buybacks was my very first posting. Seven years on, and the conclusions are still the same.
September 2005: Share Buybacks' Posting
What should investors’ opinion be of these share buybacks? Should companies make known their intentions?

We need to understand first why there is a stockmarket in the first place? First and foremost, it is there to allow companies to raise cheap funds to fund their growth strategies. Secondly, it is to allow for individuals and other entities to participate in the growth of these companies. Other reasons are secondary in nature. A company raises funds to facilitate corporate strategies, hopefully they will make money, preferably higher than the prevailing interest rate (if not, all funds should put money in the bank and close shop). Successful companies may keep accumulating profits to prepare itself for two general reasons: market down cycles, or in order to take advantage of opportunities when there is a market/industry correction/sell-down.

Companies should only indulge in share buybacks when accumulated funds are in excess for the above two reasons. This is because share buybacks will deplete reserves and may not be easily convertible to cash when there is a down cycle or market correction – the time when funds may be needed for those two purposes. Companies doing share buybacks must and should consider this aspect before embarking on the said exercise. Even then, the company can still decide on other options to do with the excess cash – give back to shareholders in the form of dividends or bonus – especially in a matured industry.




Companies raise cash for investing in growth, if they find no good investing opportunities after a prolonged period and cash flow is healthy, the funds should be returned to shareholders. Companies doing share buybacks are basically saying that that is the best way to spend their excess cash. To arrive at that decision, they must be convinced that their share is undervalued compared to their company's prospects. A company’s share price may not reflect its true potential – who knows the company’s fundamentals better than the people running them.

Then we have to look at why management is doing this – is it to improve share price via reducing the free float; and/or improve the earnings per share (but that only happens when they cancel the shares). If a company has to resort to improving their share price by reducing free float, it is usually not successful – a simple glance at the past 2 years' price performance of most of these companies will tell you that. By reducing free float, it is a futile exercise as the company will have to accumulate a significant amount to prop up the share price – that seems artificial no matter how you look at it as the only group really keen to own the shares is the company themselves.

Of course, share buybacks can successfully engineer higher share prices by massively reducing free float but they will have to meet regulations for minimum free float in the market place. The danger is that share buybacks can be taken advantage as “insider trading” by management as it involves market timing – hence the authorities must be more vigilant when it comes to the timing of share buybacks. If a company buyback the shares and do not cancel them, are they waiting to unload when price is higher? That is tantamount to trading in their own shares or having an investment portfolio. Is that part of the company’s normal course of business? Can this activity account for a substantial amount of profit for the company? How should analysts regard this profit – probably not enthusiastically as it is considered as a “one-off.”

It is safe to say that companies should make their intention known to the public when doing share buybacks – is it for future placements to institutions; to be cancelled, if so please state a time frame; not to be cancelled, but to be sold back into the market when price is higher; or to be disbursed as bonus. To me, that is vital information and I believe investors will rate the stock accordingly with the new information.




Bottom line, if it is not going to be cancelled, share buybacks are not really that big a positive in rating the company. Most times, companies who do share buybacks will not see significant improvements in their share price – investors do not rate a company higher because of that as investors are not buying the stock in the first place for various other reasons, and the free float is not really a major reason. Any worthy share buyback has to be cancelled for it to be effective.

Companies not doing that, need to ask themselves more questions as to why their share price is not at a level where it should be – are investors not happy with the management’s vision; is the company not communicating its plans effectively; has the company not been able to chart a credible track record; have the financial results for the company been haphazard or inconsistent; is the company too unfocused or too diverse that nobody even wants to follow/research the company; how is the management track record been in treating minority shareholders; have transactions or deals been really fair to all shareholders or been forced down investors’ throat (oops, getting too specific here) – chances are the stock will be rated properly if the above concerns have been addressed. Hence most share buybacks will not be entirely successful as it is fighting against the “enemy” when the “enemy” is really internal not and not external.

10 comments:

elizabeth said...

I think, in a down market like this, no amount of share buyback will help to shore up the stock prices.. I suspect, major shareholders will benefit, as they can increase their equity interest in a company, without spending a sen of their own money. I also wonder, if a major shareholder interst nudged over the 50% mark as a result of the buyback activity, will there be exemption from the takeover code?????

Some of these companies that are active share buyback counters, they have the funds to engage buyback, but are very stingy with dividends... like that, how can the share price move??? Give good dividends, and ensure a healthy float so investors can trade in and out with ease, and I shld imagine share prices wld move...

jake said...

Would like to know ,what is thier intention of buying back their shares?I have followed KONSORT for a very long time.Since they are buying the price of their share has increase 20%.Would appreciate if you could give me insight on this particular counter.

Salvatore_Dali said...

jake,

i dont particularly follow konsort anymore ... but it would be fair to say that there is hardly any institutional or long term holders of the shares ... if yr shares has dropped so much that nobody wants them, and u do share buyback, the px may move up... again, no intention declared on what they want to do with the shares.. if u jump in u will be jumping in blind

if there is really very good news (substantial contracts), dont u think the insiders will be buying... why use company funds to buy? ... probably personally they r already maxed out, or have mortgaged their shares... and need a bigger margin line, maybe i dont know.. maybe... but certainly not a reason to buy

MP said...

SD are you saying that there's the possibility of using xs company funds to warehouse shares for favored parties at below market rates?

Salvatore_Dali said...

mp,

no, thats not what i meant.... a lot of senior mgmt hold stocks, and a lot of them also have margin lines... if they read mkts wrongly and the bulk of the shares under margin is yr own company shares... one way to save u fm being margin called or to increase yr line of margin is to boost yr company's share px... if investors do not find yr stock appealing but yr company has some funds, in some cases, share buybacks may be a way to do that

KoSong Cafe said...

An excellent article and a good chance for me to ask some questions from an expert.

I have been under the impression that window-dressing refers to, say, company year-end is Dec 31 and someone wants their company's investments to look good, so they make sure a minimum number of shares under their portfolio are bought at the end of last trading day. It will look good on paper based on the market price at Dec 31. But I used to come across journalists referring to window-dressing activities way before last trading day.

The other point is that even during a stretch of bear market, there is description of 'profit-taking activities' which pulled down the prices!

Salvatore_Dali said...

kosong,

technically speaking, only investment companies do window dressing, esp gov related investment bodies so that their performance looks ok.. companies themselves dont do that... window dressing can occur a few days before book closing as these may be fake window dressing... ie... buying and selling among same funds... if i have a fund that has 18% return and another at 9%, you can either shift some positions around to make things look better, maybe not in actual performance but may improve how the portfolio would look in terms of actual holdings and exposure

we never know, maybe they even adjust a historical entry price which would make the poor fund as having some gains... it happens

thats the journalists and analysts fault... if mkt drops from 1500 to 1300 over a couple of month, and dips to 1100 over another month... where got profit to take... but it sounds better than cutting losses

KoSong Cafe said...

Thanks for the information.

I find the information given in newspapers on listed companies' PE, DY and NTA unreliable. It is a case of 'use it at your own risk' and nobody bothers as the mistakes are too numerous to point out. Isn't it worse to have wrong information than no information?

For eg. penny stocks having fantastic PE ratios or high NTAs. I use Maybank's online stock info and even that is not totally accurate. For eg. after new shares (bonus or sub-division or whatever is called where 1.00 reduced to 10sen) the highest and lowest prices are not adjusted.

So poor people who relies on cheap info from newspaper literally 'koo' (Cantonese for guess) when they buy or sell 'koo phiu'!

hng said...

Dear Dali
Do do agree company buy-back their share only if company is in net-cash position? I wonder why a lot of property stock buy back share while having borrowing in balance sheet or high gearing. Company such as YNH property, sunrise, Glomac even raise fund via private placement or right issue to increase working capital (Property is capital intensive sector). But why these company instead use fund for buying back their own share? Can't justify their motive! They should channel their fund to increase ROE. Another example is IGB, which trade its own share by buy/sell in the market. On the other hand, YTL power, actively perform share buyback and latter distribute it as dividend in species, however, the amount of oustanding share remain unchanged or even getting higher as convertible bond/warrant exercise their option. Other example like Fimacorp, Daiman development, Jaycorp etc are low volume trading stocks and yet still wanna to buyback share!

DanielXX said...

Share buybacks have been accused of helping to support share prices in companies which offer their executives generous options, so sometimes the intentions behind these share buybacks can be a bit dodgy. End of the day, it still boils down to whether you feel the fundamentals warrant the company exchanging its cash for shares, the main metric being the benefit(earnings) that each share commands relative to its cost(price) ie. PE.