VALUE INVESTING
There's No Value In Share Buybacks

By Stephen Bland (TMFPyad)
April 2, 2004

Share buybacks seem to be gaining in popularity. As one example, a company that I hold, Alliance & Leicester (LSE: AL.), has mounted a very large series of buybacks in recent times. Although the individual amounts are fairly small in relation to the issued capital, the total number of shares bought, and the money involved, do start to become serious. A process which, if continued too far, could result in the company disappearing up its own fundament.

Over the last six months or so, I calculate that A&L has purchased around 12.5m of its shares, at a total cost of somewhat over £100m. That £100m could have resulted instead in a dividend of around 21p per share. To put that into context, the latest annual dividend was 48p, so an additional 21p would represent quite a worthwhile extra income to shareholders as a one-off special dividend.

This company has an outstanding dividend record anyway - one of the reasons why I selected it for my first High Yield Portfolio (HYP) three years ago, and also why I featured it recently as one of the monthly selections for the HYP section of my Value Investor newsletter. But, even with A&L's good payout record, I am sure that most small investors would far rather have an additional dividend, even if only for one year, than see the money spent on share buybacks that do not put the money in their hands.

I don't agree with buybacks in most circumstances, and this is one of them, because they offer little direct benefit to shareholders, when compared with the alternative of using the cash to pay a higher or special dividend. Buybacks will normally increase earnings per share, which aids share-price growth, and the act of buying shares in the market may help to hold or increase the price at that point. However, these are nebulous advantages to the investor, because of all the other forces that act upon share prices. You can't, in my view, beat a dividend as a way of giving spare cash to shareholders, because it puts an exact sum of money directly into their pockets. Against that, it is impossible to see the effect of buybacks on the wealth of the investor.

Looking at A&L since October 2003, the earliest buyback was in that month at 893p. In fact, the share price is slightly lower now. So, what use was the buyback? Would the price have been even lower without several buybacks? Who knows. That's part of the problem - you cannot measure the effect. Yes, earnings per share (eps) will be enhanced very marginally, but too little to make any serious difference to investors, so the result is that shareholders have really not drawn much benefit at all from the company's expenditure of that enormous sum of £100m on buybacks since that date.

Yet despite this, and I use A&L only as an example, there are many buybacks elsewhere. It seems far more common for companies to utilise buybacks than to pay out surplus money in dividends. The question is: why? I have a strong suspicion that it is more to do with enhancing directors' reputations than with enhancing shareholders' wallets. If earnings per share rise over time, then the directors can present this as an achievement.

Naturally, eps over the years is affected primarily by the company's profitability, not buybacks, but the latter will aid slightly the process of trying to achieve a growing trend. And since the money is presumably surplus to requirements, I have a cynical feeling that they think they might as well do something with it, once the decision has been made to pay it out, which helps their image - whilst at the same time they can claim that shareholders have benefited by the rise in eps.

In terms of share-price performance, I cannot see any measurable advantage to shareholders that results from buybacks. In contrast, the gain to shareholders from additional dividends is unequivocal.

Particularly for the equity income investor, but for all value investors, it makes no sense for companies to organise share buybacks instead of paying out the cash as dividends. Unfortunately though, there ain't a lot the small investor can do about it, other than lobby the boards of companies who do this to change their policy in favour of dividends.