Do Share Buybacks Benefit Investors? Warren Buffett Thinks So

We’re seeing a phenomenon in corporate financial reports that we rarely observed in the past. Earnings per share (EPS) are growing at a faster rate than net earnings.

The 2022 results for The Home Depot are an example. The company reported a profit of $17.1 billion last year (figures in U.S. dollars) up 4.1 per cent from $16.4 billion in 2021. But EPS increased 7.4 per cent, to $16.74. Why? Because of a decline of 3.1 per cent in the common shares outstanding, as a result of stock buybacks.

It appears 2023 will be a record year for buybacks in the U.S. Companies in the S&P 500 are projected to spend more than $1 trillion for the first time in a calendar year, according to S&P Dow Jones Indices.

Authorizations for repurchases are increasing rapidly. As of mid- February, they totalled more than $220 billion, a record for that point in the year, according to Goldman Sachs.

U.S. companies leading the way are Chevron (a $75 billion buyback authorization), Meta Platforms ($40 billion), and Goldman Sachs ($30 billion).

In Canada, 5i Research tracks companies with the largest share buyback programs. The criteria are that they must have a market cap of more than $100 million, net debt to EBITDA ratio of below 3.0x, and repurchased more than 5 per cent of outstanding shares in the last 12 months.

For 2022, 5i identified the buyback leaders as Medical Facilities Corp. (a reduction of 16.7 per cent in shares outstanding), Interfor Corp. (-15.4 per cent), Imperial Oil (-13 per cent), Frontera Energy (-11.7 per cent), and Leon’s
Furniture (-11.6 per cent).

Do investors benefit from this? Generally, yes, but not as much as you might think. The S&P/TSX Composite Buyback Index is up 4.75 per cent this year (to March 10). The average annual return for five years was 6.91 per cent. The top five companies in the index are Royal Bank, TD Bank, CN Rail, Canadian Natural Resources, and Alimentation Couche-Tard.

The main argument in favour of buybacks is that by reducing the number of shares outstanding, the value of those left in circulation is increased. So, the same profit is spread over fewer shares, thereby improving earnings per share.

It’s also argued that buybacks signal a company’s confidence in its future and a belief that the market is undervaluing its stock. But share buybacks have become increasingly controversial. Some investors see them as an indication of flabby leadership, with directors and managers failing to identify growth opportunities. Politicians dislike them because the money spent purchasing shares does nothing to create new jobs or modernize or build new facilities.

The U.S. imposes a 1 per cent tax on buybacks, which President Joe Biden proposed increasing to 4 per cent in his recent State of the Union address. Canada plans to impose a 2 per cent tax on share buybacks in 2024.

Warren Buffett is a strong advocate of buybacks. His own company, Berkshire Hathaway, bought back 1.2 per cent of its outstanding shares in 2022. Two of its main holdings, Apple and American Express, also bought back their stock.

“The math isn’t complicated,” Mr. Buffett wrote in his annual letter to shareholders. “When the share count goes down, your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices.” (His italics.)

He went on: “Gains from value-accretive repurchases, it should be emphasized, benefit all owners – in every respect. Imagine, if you will, three fully informed shareholders of a local auto dealership, one of whom manages the business. Imagine, further, that one of the passive owners wishes to sell his interest back to the company at a price attractive to the two continuing shareholders. When completed, has this transaction harmed anyone? Is the manager somehow favored over the continuing passive owners? Has the public been hurt?

“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”

Strong words from a man known for his quiet moderation. Warren Buffett clearly believes that buybacks are good for investors, unless the company is overpaying for the stock. In that case, everyone loses and it’s time to exit.

Most companies who are repurchasing shares include the information in their quarterly and/or annual reports. Pay attention to the results – how much was paid out and the average cost of the shares purchased. If the purchase price is averaging more than the current market value of the shares, you may want to rethink your investment.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca . Follow Gordon Pape on Twitter at twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney

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