What Investors Should Know About Share Buybacks

Companies buying back their own shares from shareholders is very common. This practice is referred to as a share buyback or stock buyback. This moneyland.ch guide answers the important questions about share buybacks.

What is a share buyback?

A share buyback is the process in which a publicly traded company buys back its own shares. Typically, this is done using the company’s surplus cash. Share buybacks are normally decided on at a company’s annual general meeting (AGM). Swiss companies are allowed to repurchase up to 10 percent of their own shares in a share buyback. 

There are two common ways in which companies buy their own shares:

• On stock exchanges: This version is the most widespread. The company simply buys its own shares on stock exchanges in increments over a certain period of time. 
• Directly from shareholders: The company makes its shareholders an offer, and investors can sell their shares to the company if they choose to.

Share buyback programs are relatively common in Switzerland. In 2022, companies traded on the SIX Swiss Exchange bought back a total of 34 billion francs worth of shares. That translates into 3.7 percent of the total market capitalization.

Why would a company buy its own shares?

There are a number of different motives that could drive a company’s decision to repurchase its shares. Common reasons for a share buyback include:

• Building trust: A share buyback can send out a positive signal, with the company aiming to demonstrate that it believes in its business model. This can motivate investors to invest in the company, and help to stabilize a weakening stock price.
• Using up surplus liquidity: If a company has surplus cash, a share buyback can offer a proven way to use up this unneeded liquidity.
• Preventing hostile takeovers: Share buybacks can help to protect companies from hostile takeovers. The reason is that the more of a company’s shares are under its own control, the less shares are available for purchase on the free market.

What are the advantages for investors?

Share buybacks reduce the number of shares available to investors. That means the company’s profits and dividends are split between fewer shares, which increases the profit per share. A share buyback often results in the stock’s price going up. Even the announcement of an upcoming share buyback is often enough to push up the stock price. But you should be aware that these hikes in the value of shares are often short lived.  

What are the risks and disadvantages of share buybacks?

Critics consider share buybacks to be poorly-invested money – or even a desperate, uncreative attempt to keep shareholders happy. You should understand the following possible disadvantages: 

• No long-term added value: The effects of share buybacks usually do not last long. If a company spends money on buying back its shares, that money is no longer available for investments or long-term projects. That can be dangerous for a company, especially if needed investments are pushed aside in favor of buying back shares.  
• Possible debts: If the share buyback is done using borrowed money and pushes the company into debt, it can have devastating effects on the company’s financial health. 
• Bad timing: If the time at which shares are repurchased is unfavorable – when the stock price is relatively high, for example – then the share buyback can become expensive.

Is it possible to make targeted investments in share buybacks?

If you want to invest specifically in companies that are launching share buyback programs, you will generally have to follow the news closely to get informed about possible share buybacks as early as possible. In the best case, you may be able to buy into the stock early on. As a private investor though, this process can be time-consuming and complicated.

If you want to profit from share buybacks, but prefer not to put in a lot of time and effort, then investing in a specialized exchange-traded fund (ETF) is an alternative. These buyback ETFs replicate stock market indexes that track companies with share buyback programs. The exact criteria governing which stocks are included vary between indexes.

Example: The Nasdaq Global Buyback Achievers Index only tracks companies that have reduced the number of shares available on the stock market by at least five percent

Note that share buyback indexes – and the ETFs that replicate them – only include stocks based on past share buybacks. There is no guarantee that a company will initiate new share buybacks in the future.

Focusing too closely on buyback stocks and ETFs to the detriment of diversification is not recommended. However, you could consider investing in companies with share buyback programs as part of a core-satellite strategy. In that case, the share buyback investments would be a satellite, while the bulk of your portfolio would be made up of a diversified core (a global index, for example).

How well do share buyback ETFs perform?

A performance comparison between a share buyback ETF and the popular global index MSCI World provides interesting insights. Over the past five years, the share buyback ETF performed better. Over the past 10 years, the more widely diversified global ETF had better performance

Important: These performance figures are just snapshots of performance over a very specific period. Depending on the timeframe used, the results can look very different. It is also important to note that past performance is never a clear indicator of future performance, which is impossible to predict. Theoretically, both high gains and big losses are possible at any time.

Note: This article is provided for informational purposes only, and should not be considered as investment advice. The publisher does not accept any liability in connection with this publication.

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