Buyback or By-back, buyback (from English. buy back – buyback) — redemption by the issuer of its own shares.
In most cases, share buybacks by a company are considered to be an indicator of the company's surplus cash., however, it is often a forced measure, against the fall in the company's market value. As a result of this transaction, net earnings per share increase., which entails an increase in confidence in the company among investors and has a positive effect on exchange rates. Repurchase of shares for their subsequent cancellation avoids the dilution of the company's capital due to the issue of new securities.
During periods of market decline, the number of companies increases, who announce the buyback of their shares. Share buybacks are fairly common. Nevertheless, The trading community often does not realize the value of such news and the possibility of using them in the process Investment or analysis.
Why Companies Buy Back Their Own Shares?
Buyback operations, usually, are held in order, to
- Get rid of liquidity, which the company considers excessive,
- change the capital structure,
- receive benefits in calculating dividend tax,
- reduce the risk of hostile takeovers,
- use the repurchased shares to pay for the acquisition of other companies,
- transfer the repurchased shares to the employees of the company,
- improve the ratio of the market price of a share to earnings per share.
- and the most important motive, which can be considered the most rational of all – it is to make a profit on investments in your shares due to their underestimation by the market and the excess of the intrinsic value over the market value.
The issuer buyback procedure is often seen as a means of maintaining market stability and demonstrating to the market that management believes in the company's reliability.. In world practice, this method of maintaining the activity of the stock market is used quite often.. So, after the US stock market crash in October 1987 years, the largest companies announced their intention to buy back shares for more than $9,0 billion.
After Black Tuesday - the terrorist attack 11 September 2001 In the United States, the rules for buying back shares were relaxed to support the stock market (then the index fell by more than 680 points). The Chinese authorities have taken similar steps in the context of the global financial crisis.. In September 2008 G. a specially created state commission for the regulation of the securities market has significantly simplified the procedure, related to the repurchase of shares of companies, listed on the stock exchange. Under the new rules, to buy back shares, it is enough to make public the intention and inform the state commission about the transaction. This eliminates the need to submit an application and seek regulatory approval. This decision was intended to help stabilize the Chinese stock market., felt the negative consequences of the global crisis.
In most countries, the tax rate on dividends is higher, than the capital gains tax rate. Consequently, it is not profitable for shareholders, for companies to pay dividends. There are studies, Prove, that the integration of taxes into the Modigliani-Miller model leads to the conclusion that it is advisable to refuse to pay dividends. So, Grullon и Michaely, examining a sample of 2735 share repurchases on the open market from 1980 to 2000 year, showed, that due to the excess of the tax rate on dividends over the tax rate on capital gains, dividends may not be used as payments to shareholders, and share buyback. Allen and Michaely conducted a study of the tax effect of dividend payments in the US market and obtained the following results: paying high dividends, firms reduce their value when there are transaction costs and in the absence of the possibility of full hedging of risk.
What is a share buyback??
The procedure for a company to acquire its own shares on the open stock market is called “buyback of shares”, and the acquired shares – “treasury shares”. Before moving on to analyzing the benefits and dangers, associated with such an event, how a company buys out its shares, let's look at some terms, which are often used in this connection:
Shares authorized for issue (Authorized Shares) – number of shares, which the company is allowed to release in accordance with its statutory documents. Board of Directors, with the consent of shareholders, may authorize the issuance of an additional number of shares.
Outstanding shares (Outstanding Shares) – number of shares, in the hands of investors (including employees and company managers). This number does not include treasury shares and stocks., approved for release, but not released.
Treasury shares (Treasury Shares)- number of previously outstanding shares, which was bought by the company. Treasury shares can subsequently be sold or withdrawn from circulation, depending on the decision of the shareholders.
Shares in free float (Float) – this is the number of shares, in circulation, minus those, which are in the hands of insiders (ie. such company employees, as president, vice president, executive director, etc.), as well as treasury shares.
Earnings per share (EPS) – total profit, divided by the number of shares outstanding.
Now, when we defined the terms, let's move on to a more detailed look at the effect (positive or negative), which may have a share buyback procedure.
Advantages of share repurchase
Increasing shareholder value. There are many ways to measure a company's profitability., but the most common indicator is EPS (earnings per share). If the profit from one reporting period to another remains at the same level, then the company can achieve the coveted EPS growth by reducing the number of shares in circulation.
Increase in share price. EPS growth often serves as a signal to investors that, what stock undervalued or has the potential to increase in value. Usually, this leads to an increase in demand and stock prices.
Increase in the share of shares, in free circulation. As the total number of shares outstanding is dwindling, then the remaining shares have a larger percentage of the number of shares, in free circulation. If demand rises, and the supply is decreasing., then there is fuel to move the stock price up.
Excess cash. Companies usually buy back their shares for excess cash. Since the company has excess cash, then we, least, we can hope, that it will not create a cash flow problem. More importantly, what does this tell us about, what company executives think, that the reinvestment of funds in the enterprise will bring the best return, than any of their other attachments.
Income tax. When excess cash is used to buy back shares in a company, rather than going to pay higher dividends, shareholders have the option of not showing capital gains and reducing taxes, payable if the share price rises. Dividends are taxed as ordinary income for the year, in which they are received, and stocks that have risen in price are taxed only after they are sold. Besides, if the shares have been held for more than one year, then the capital gains tax rate is lower.
Price support. Companies, having a share buyback program, use periods of weak market, to more aggressively buy up your shares on market pullbacks. This demonstrates the company's confidence in its future and tells investors, that the company considers its shares to be undervalued. You can often see, how a company announces a buyback after a share price falls, what is being done on purpose, in order to get promotions at a discount. This creates support for the stock price., which ultimately instills confidence in long-term investors, despite difficult times in the market.
We looked at factors, which can serve as the basis for the purchase of shares of the company, which announced the ransom. But is it necessary to rush to invest in every company?, made such an announcement? Undoubtedly, No. Not all ransoms are the same. Some of them are just an attempt to manipulate the stock price..
When the company has the right to conduct a buy-back
Share buyback rules are slightly different, if we consider the countries of Europe, USA and Russia. Europe's strictest buy-back rules, where companies can only afford to buy back 10% their shares. At the same time, the management of a European company is obliged to approve its statement at the general meeting of shareholders..
In the United States, any company has the right to buy from the market up to 25% their shares, in circulation. If the redemption of securities does not exceed the threshold of 10%, then it is enough for the company to provide an official statement and obtain the approval of the Board of Directors.
Potential traps
Profit manipulation. The above was told, how buyback improves reported earnings per share. Analysts determine a company's rating based on many factors, and one of the most important among them – earnings per share. Suppose, what the analyst estimates the profit, based on more shares outstanding, which existed prior to the execution of the ransom procedure. Choosing the right moment in time, the company can, by repurchasing their shares, surpass the consensus assessment of experts, which was based on more shares outstanding. Therefore, you need to pay attention, whether the announcement of the share buyback is made just before the release of the profit statement.
Redemption percentage. The higher the percentage of redeemable shares, the greater the profit potential. Unfortunately, the redemption percentage is usually not announced, that's why, to determine the degree of importance of a given event, have to do some research on my own. Remember, that a large number of shares does not mean a high percentage.
Execution of the ransom. There is a difference between the release of the buyback announcement and the actual buyback of shares.. Initially, a buyback announcement can accelerate the share price, but usually this effect (if it happens) – short. You are wrong, if you think, that all buyback announcements are being implemented. A significant part of them remain completely unfulfilled..
High share price. Beware of ransom programs, announced, when the share price is near its historical High. Share buybacks can be used to manipulate unwanted expectations for EPS. One way to find it out – compare price / earnings ratio (R / E) with other stocks in the same sector or industry. If the price / earnings ratio is higher than usual, then such a company makes absolutely no sense to buy back its shares at a high price, unless there is some factor, which will significantly increase profits.
Duration:
Buyback programs can last for several years. This is especially noticeable in the example of international IT giants..
So, for example, IBM with 1995 annually redeems its shares for 10 billions of dollars and does not intend to change its policy regarding buy-back procedures. Microsoft came to this practice later., nose 2006 on 2010 a year already bought back its own shares from the market for 78 billion dollars, then launched buyback on 40 billion dollars (end date: 30.09.2013), and 17.09.2013 announced a new perpetual buyback program for another 40 billion dollars, which should replace the previous buyback ending with 30.09.2013.
In October 2008 of the year, in the midst of the global financial crisis, Oracle Corporation announced the start of a large-scale program to repurchase its shares with a total volume of more than 9 billion dollars. Moreover, Oracle said, that their shares will be bought up without a specific program, guided by the current market situation and the financial position of the company[3].
In March 2010 of the year, the world's largest manufacturer of mobile processors Qualcomm announced, that he plans to carry out the procedure for the buyback of shares in the amount of about 3 billion dollars.
In July 2010 of the year Internet giant Yahoo! announced the implementation of a three-year buyback program for a total of 3 billion dollars. As analysts say, “The purchase of shares will further convince the market that Yahoo's shares! will continue to grow
Buyback and price manipulation
On the other hand, some unscrupulous issuers use share repurchases to manipulate the price. As mentioned above, buy-back provokes an increase in EPS, and as a result of its growth, analysts will be forced to state a higher real value of the company.
To distinguish banal manipulation from targeted actions in favor of shareholders, it is worth considering the market situation, in which the buyback of shares is announced. If the procedure is carried out during the period, when the price is close to historical highs, probably, this is an unjustified desire to inflate the price even more. If the buyback is carried out in conditions of low prices, this situation most often develops in favor of investors.
Among other things, you should compare the P / E of the company, repurchasing its shares at P / E of peers in the industry. If the P / E is too high first among the others, then buying at such a high price has no real meaning. When a firm buys up its own securities under the specified conditions, should be understood, that this is an attempt to inflate the EPS ratio.
If the company plans to buy back shares, this indicates that she has a surplus of monetary resources, which means, it can be concluded, that there are no problems with the flow of money. At the time of the announcement of the planned buyout, the growth of the company's exchange-traded assets may begin, but more often it lasts a short time. The buyback procedure itself is also accompanied by an increase in quotations, the price increases against the background of growing demand for securities, while the supply of shares decreases (because. there are fewer of them in circulation).
Benefits for investors
The importance of buyback for individual market participants is in direct proportion to the number of assets purchased from the exchange.. The higher the proportion of redeemed securities and securities, in circulation, the more opportunities exist for making a profit. However, the rise in prices at the time of the announcement of the buyback is not too large., therefore it becomes interesting mainly for players, holding stock for a short time.
Output
Share buyback programs aim to manage supply and demand by reducing the number of shares outstanding, increase in value for shareholders in the form of an indicator of earnings per share, an increase in the share of free float shares and, eventually, increase in share price. Besides, buyback is a prudent use of excess cash and tax advantages for investors. But not all buyouts are implemented in practice., therefore, in order to avoid unjustified losses on your trading account Caution should be exercised and analysis should be carried out
Некоторые критики утверждают, that ransoms are hidden costs, associated with the award of management of shares or options. By rewarding executives with stock or option certificates, the company usually repurchases the corresponding number of securities in the open market, preventing them from increasing their total number. At the same time, in the balance sheet, redemptions are usually not included in the cost of compensation..
Analysts want more company transparency. Сейчас практика выкупов позволяет руководству «получать больше, than reflected in the “compensation” column of the income statement”, - these are the results of the study, проведенного в октябре инвестиционно-аналитической компанией Research Affiliates.
Mark Clements, co-author of the report, notes, that the salaries of executives sometimes also depend on the growth of EPS, which serves as an additional incentive to carry out buyouts. Overall, critics agree: выкупы — искусственный, short-term method of approaching approx. Sometimes active redemption of securities is carried out in quarters with poor results - there is a banal manipulation of profits.
In a message to companies, Blackrock CEO Larry Fink writes, that "an increasing number of corporate leaders" are resorting to "tricks like buyouts or dividends, стремясь увеличить сиюминутную выгоду акционеров, while reducing investment in innovation, Qualified labor resources or capital closures, needed to sustain long-term growth”.
