SHARE BUYBACKS EXPLAINED: WHEN THEY CREATE VALUE (OR NOT)

Share buybacks, also known as share repurchase programmes, occur when a company purchases its own outstanding shares from the open market or directly from shareholders. This practice reduces the number of shares available publicly, often resulting in a higher earnings per share (EPS) figure and, potentially, an increase in share price.

Companies often utilise excess cash to undertake buybacks as an alternative to investing in new projects or increasing dividends. The reasons can range from signalling confidence in the firm’s future to structuring a tax-efficient return of capital to shareholders. However, the implications and outcomes of buybacks vary widely based on timing, intent, and execution.

The prevailing motivations for share buybacks include:

• Optimising capital allocation: Instead of leaving idle cash on the balance sheet, firms may return excess capital to shareholders via buybacks.
• Positive market signalling: Management initiating a buyback can signal belief that the business is undervalued.
• Boosting financial ratios: By reducing the total number of outstanding shares, buybacks typically increase EPS and return on equity (ROE), even if total earnings remain constant.
• Offsetting dilution: Corporations often use buybacks to neutralise the dilutive effects of issuing stock as employee compensation.

Buybacks can be executed in several ways:

• Open market repurchases: The most common method, where shares are bought at prevailing market prices over time.
• Tender offers: Companies might offer to buy shares at a premium price within a specific timeframe.
• Private negotiations: Some firms repurchase shares from a single large shareholder.
• Accelerated share repurchase (ASR): A company buys shares upfront from an investment bank, which then repurchases the same from the market.

While the mechanics may seem straightforward, the real impact of a share buyback hinges on several factors including valuation, opportunity cost, and investor perception.

Buybacks create genuine shareholder value when executed under the right conditions. They are not universally beneficial, and their effectiveness depends on the firm's financial condition, the share price, and broader strategic alternatives. Essentially, a buyback is a capital allocation decision — and must be evaluated as such.

1. When Shares Are Undervalued

One of the strongest justifications for a buyback is that the company’s shares are trading below intrinsic value. In such cases, a repurchase is akin to acquiring a high-return investment. The fewer the shares in circulation, the larger the stake each remaining shareholder effectively holds — accentuating per-share value.

For example, if a firm with strong fundamentals sees its stock price depressed due to short-term market volatility, repurchasing shares can offer superior returns compared to lower-yielding investments such as treasury securities or even dividend hikes.

2. Enhancing Capital Efficiency

Companies with limited opportunities for organic growth may view buybacks as an efficient way to deploy idle capital. Provided operations are stable and debts are manageable, share repurchases can boost return on equity (ROE) by narrowing the equity base.

Some firmly established businesses maintain high cash flow yields and lack breakthrough innovation pipelines. For them, funding a buyback can be preferable to investing in uncertain ventures or hoarding cash that diminishes return metrics.

3. Tax-Favoured Returns to Shareholders

Buybacks offer a more tax-efficient alternative to dividends in jurisdictions with capital gains tax advantages. Rather than receiving taxable income from dividends, investors realise gains only when they sell shares, allowing for strategic tax planning.

4. Offsetting Dilution from Stock Compensation

Firms with robust employee share-based compensation plans may repurchase shares simply to prevent dilution of existing shareholders’ ownership. In this context, the buybacks are value-neutral — they preserve rather than enhance equity per share — but may be beneficial in upholding shareholder structure and confidence.

5. Signalling Strong Management Confidence

Buybacks often communicate that management expects share prices to rise, suggesting underlying strength in business fundamentals. Such signals can buoy investor sentiment and bolster valuations, even beyond the mechanical boost to EPS.

Nevertheless, signs of genuine value creation include cautious buyback pacing, transparency about rationale, and not leveraging excessive debt for repurchases — all markers of responsible capital stewardship.

Despite their popularity, share buybacks are not without controversy. When conducted under poor conditions or for the wrong reasons, repurchases can erode value for shareholders and weaken the long-term position of a company.

1. Overpaying for Shares

The clearest way a buyback destroys value is when companies repurchase stock priced above its intrinsic worth. Unlike buying back undervalued shares, overpaying effectively transfers wealth from continuing shareholders to those cashing out. Since capital used for overvalued buybacks isn't reinvested productively, it represents inefficiency and opportunity loss.

In fact, studies have shown that many companies mistime buybacks — purchasing more stock when prices peak, and fewer shares during downturns — which negates their intended benefit.

2. Crowd-Pleasing at the Expense of Strategy

Buybacks can be used to satisfy short-term market pressures or boost per-share metrics ahead of earnings reports or executive incentive evaluations. While such tactics can enhance quarterly optics, they often sacrifice investments in innovation, R&D, and long-term corporate infrastructure that support sustainable growth.

This becomes especially problematic when companies prioritise buybacks over capital expenditures (CapEx) or ignore promising expansion projects that could yield higher returns than repurchasing overpriced shares.

3. Reducing Financial Flexibility

Funding buybacks through debt — especially for firms with already strained balance sheets — can increase financial fragility. The burden of debt repayments and shrinking cash reserves may become acute during economic downturns, reducing future resilience. Furthermore, buybacks executed during boom times leave little buffer during contractions when purchasing undervalued shares would be most advantageous.

4. Masking Poor Operational Performance

Some firms use buybacks to prop up EPS even when net income is stagnant or declining. This accounting-based enhancement can deceive investors, masking underlying weaknesses or operational stagnation. Over time, such strategies lead to market mispricing, misplaced trust in management, and disappointing financial results once the underlying issues become apparent.

5. Regulatory and Social Governance Risks

There is rising scrutiny around buybacks, especially from policymakers who argue that firms use them to enrich executives at the expense of labour investment or innovation. Environmental, social and governance (ESG)-minded investors increasingly monitor how companies use capital, raising pressure to justify repurchases with demonstrable strategic rationale.

For example, criticism has been levelled at firms conducting buybacks shortly after laying off employees or those seeking bailouts, suggesting misaligned corporate priorities that can harm public perception and attract regulatory intervention.

Ultimately, buybacks should complement — not replace — a robust strategic vision. When misused or mispriced, the costs to long-term shareholders can be substantial, undermining trust and value creation.