Can I make sustainable passive income from share buybacks?

Jon Smith notes the rise in share buybacks from FTSE 100 companies, but flags up why they aren’t great for building passive income.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Person holding magnifying glass over important document, reading the small print

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

When a company has excess cash that it wants to distribute to shareholders, it has two main options. It can pay out a cash dividend. Or it can use the money to buy back shares, paying the shareholders that way. Given the rise in share buybacks over the past year, is this a viable way for me to build up a passive income?

Different potential options

Share buybacks tend to happen in a couple of different ways. One way is that if I own a stock, I might get a notification of a tender offer. I can opt in to sell some of my shareholding in the firm at an agreed price. So if I own 10 shares in the firm and put forward to sell half, I’ll receive the cash value of the five shares.

A buyback can also happen whereby I’m not directly approached. Rather, the company will simply go to the stock market and purchase a set value of the company shares. Unless I choose to sell my stock, I can’t be forced to sell it.

Clearly, buybacks do have the potential to generate income if I choose to sell with a tender offer. However, it’s not that sustainable as once I’ve sold the stock, I cease to get any further benefit. This differs from a dividend, in that I can keep receiving income from dividends if I hold the stock.

Gaining from the share price

Instead of making income from a buyback, I do stand to gain from share price appreciation. After all, in taking shares off the market, there are less shares in circulation. All things being equal, this should raise the value of the share price.

So let’s say that a company wants to pay out cash to shareholders and buys back a lot of shares over the course of a few years. Even if I don’t sell mine, the increase in the share price should mean the value of my holding increases. To generate income, I can look to trim this profit by selling over time, while keeping my initial amount still invested.

A good example

Let’s consider BP (LSE:BP) as an example. Following the release of the full-year results earlier this month, the firm committed to repurchasing $14bn worth of shares by the end of 2025.

Alongside this, a dividend was also announced. Based on the $0.28 total dividend per share from the past year, the current dividend yield stands at 4.76%.

The share buyback isn’t via a tender offer, so BP will be going to the market in order to buy the stock back. The share price is down 15% over the past year, but based on the results as well as the cash being paid out, I think potential income investors will be interested.

A risk is that with the money leaving the business, BP is in a less stable financial position. Yet given that it generated a profit before tax of $23.7bn, I don’t see this being a big problem.

I’d look to buy BP shares for income via dividends, not future share buybacks. Sure, the repurchasing could help lift the share price. But in my view, buybacks are more of a signal of positivity from a business, rather than an action that should cause me to buy a stock.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Dividend Shares

Investing Articles

1 no-brainer pick I’d love to buy for my Stocks & Shares ISA!

A Stocks & Shares ISA is a great investment vehicle for our writer. Here she explains why, and one stock…

Read more »

Investing Articles

£10k in an ISA? Here’s how I’d target a regular £30k+ second income stream

Reliable dividends can help provide a lot more financial freedom. Here's how I'd aim for a substantial second income inside…

Read more »

BUY AND HOLD spelled in letters on top of a pile of books. Alongside is a piggy bank in glasses. Buy and hold is a popular long term stock and shares strategy.
Investing Articles

433 shares in this FTSE 100 dividend superstar could make me £18,803 in annual passive income!

This overlooked FTSE 100 gem has one of the best yields in the index, looks undervalued, and makes me big…

Read more »

Young Caucasian woman at the street withdrawing money at the ATM
Investing Articles

If I’d put £5,000 into Santander shares 1 year ago, here’s how much I’d have now

Santander shares have outperformed over the past 12 months, leaving this Fool wondering if he should add the bank stock…

Read more »

UK money in a Jar on a background
Investing Articles

Here’s how I’d invest £10 a week to aim for £191 a month in passive income

Stephen Wright outlines how he’d invest in dividend growth stocks over a long time to aim for significant passive income…

Read more »

Investing Articles

Here’s what dividend forecasts could do for the Aviva share price

Even after the turnaround of the past few years, the Aviva share price doesn't seem to want to move very…

Read more »

Close-up of British bank notes
Investing Articles

Here’s how I’d target £130 per week in dividends from a Stocks and Shares ISA

Using a Stocks and Shares ISA as a dividend machine does not have to be hard work. Our writer explains…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Down 6% in 2 weeks, the Lloyds share price is in reverse

After hitting a one-year high on 8 April, the Lloyds share price has suddenly reversed course. But as a long-term…

Read more »