Ask Fear & Greed: Why do companies do share buybacks?

How do companies decide when to do a share buyback? Why would they do that instead of paying or increasing a dividend?

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Episode Transcript

Speaker 1 (00:03):
Welcome to Ask Fear and Greed, where we answer questions
about business, investing, economics, politics are more. I'm Michael Thompson
and hello, Sean Aylmer.

Speaker 2 (00:12):
Hello Michael, Sean.

Speaker 1 (00:13):
This is an interesting one. It's more of anything, Michael.

Speaker 2 (00:16):
They're all interesting.

Speaker 1 (00:18):
I know, I know, but I mean some of them
are very interesting to you. Anything with economics, your eyes
just light up and you just suddenly become a buzz
with energy. And I think this is interesting as well,
but it's probably interesting to a lot of investors out there,
and not necessarily just the economists. May I go on,
please go on, please please stop talking. How do companies

(00:42):
decide when to do a share buyback? That's the question.
There is a supplementary little follow up question here. Why
would they do that instead of increasing or paying a dividend?

Speaker 2 (00:54):
Ah the dark heart of capital management? Michael go on. So,
when a company finds itself with a stack of money,
it's got a bunch of options, right, so it can
pay down debt. So when I worked at Fairfax, Fairfax
Old Trade Me which was a New Zealand place, which
is a New Zealand asset, got a stack of cash.

(01:15):
Fairfax had lots of debt. They paid down the debt
and in fact, the CFL at one point showed me
the bank account and Fairfax had money in it, and
he was very excited that he had no debt. So
that's an option, right, you got cash, pay down debt. Okay,
that's option one, Option two invested somewhere. So look at
all the gold companies at the moment. Stacks of money,

(01:35):
get price of goals high. They got cash cash coming
out the UA Zoo. You're getting Goldfield and gold Road,
that m and a deal Newmont trying to buy Degray Mining.
You're getting lots of corporate activity because there's lots of cash. Right,
So that's option to invest it somewhere.

Speaker 1 (01:52):
Okay, yep.

Speaker 2 (01:54):
Number three three a dividend or a special dividend. So
when you've got a stack of cash, and if you
think of the big miners in recent years and the
banks in recent years, they've just got a lot of cash.
If the executive team and the board can't see something
to buy that'll give them a better term, then they say, well,
let's just pay a dividend. Now. With dividends, companies tend

(02:17):
to like steady dividends, so if all of a sudden
you've got to stack of cash, you might pay a
special dividend. It's a one off dividend. Normally though, they
just like dividends just to be steady. We had a
story about soul Pats this week where it's increased its
dividend every half year since two thousand, has paid one

(02:38):
every year since nine and oh six. That's how it works. Occasionally,
COVID was an example where dividends are cut, but most
companies don't like to do.

Speaker 1 (02:46):
That, and so a special dividend is that then paid,
rather than just increasing the normal dividends. So on goes
back to normal the next year. It's not compared unfavorably
to the previous years.

Speaker 2 (02:59):
Event exactly. That's exactly right. The fourth option, the share
buy back.

Speaker 1 (03:05):
Oh here we go, Now what are we want? Three
and a half minutes in and you're finally addressing the
quidna I'm kidding. That was all important context.

Speaker 2 (03:13):
Please go please. So in recent times, the big tech
companies in the US in particular have undertaken huge buybacks,
like hundreds of billions of dollars when it comes to
the Magnificent seven. When they buy back stock, they buy
the stock, they cancel it. It means that future earnings
is divided by fewer shares. That increases the return on

(03:35):
each individual share. So we've got four options. You've got paydown, debt, invested,
dividend slash, special dividend, share buy back. Mostly companies make
the decision on what they think is going to give
them the best return today. So you can look in

(03:58):
hindsight and say why they're or did they do a
buyback when they should have invested in something. But boards
executives are saying, right now, are we better to cancel
some shares, do a share buyback, cancel some shares because
there's nowhere better to put the money. And that often happens.
I mean, there's a bunch of buybacks going on on
the ax at the moment. Or like the gold companies,

(04:20):
they think, well, you know, we've got plenty of cash,
we can afford to buy other operators. Scale matters in
gold mining, and so maybe that's a better way to
do it. So it's quite I mean, it is fascinating.
In fact, earlier in this I talked about Newmont buying
to Gray Mining. That's not right. It's Northern Star buying
to gray Mining. I just correction there, Michael. So it's

(04:44):
what they think in that moment is going to give
the best shareholder return, and that's why they make that decision.

Speaker 1 (04:50):
Gotcha, okay. And so in answering the question how do
companies decide when to do a share buyback, it's really
not a decision made in isolation. It's assessing each of
those other options and then decide to share buy back
is the best option for that current point in time.

Speaker 2 (05:06):
Yeah, and to be honest, there's another option they might
decide that. So Westpack at the moment is doing a big,
big spend on getting its technology stack all as one.
It's got all these legacy products. So they could have
used that money for something else, but they think, actually
the best return for shareholders is to fix that PW
tech stack. Ye, future earnings will be better if we

(05:26):
can get that, right. So that's actually a fifth option.
So there's that as.

Speaker 1 (05:30):
Well, investing back in themselves.

Speaker 2 (05:32):
Essentially five options.

Speaker 1 (05:35):
If you've given options, I asked you a two part question,
you gave me a five part answer. That's a record.

Speaker 2 (05:41):
That's what I ask fear and Greeds about.

Speaker 1 (05:43):
Indeed, it is thank you very much, Sean.

Speaker 2 (05:45):
Thanks Michael.

Speaker 1 (05:45):
Remember if you've got something that you'd like to know,
then please send three your question on LinkedIn, Instagram, Facebook,
or head along to our website Fearangreed dot com dot au.
I'm Michael Thompson and this is ask Fear and Greed