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Investing insights

The rise of share buybacks – what do they mean for investors in 2024?

With near 40% of the FTSE 100 buying back shares in 2023, we ask expert fund manager Nick Shenton what they mean for investors.
Businessman using a mobile phone to check stock market data.jpg

Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The UK is home to lots of world-class companies.

There are international giants selling their goods and services across the globe that aren’t just reliant on the strength of the UK economy to thrive.

There’s also a diverse array of innovative higher-risk smaller businesses, some of which are pioneers of emerging industries with the potential to blossom into the giants of tomorrow.

Importantly, the UK market continues to trade at a material discount to other markets. And companies aren’t waiting for investors to wake up and realise, they’re taking action and buying back their own shares. Last year, nearly 40% of the FTSE 100 bought back their own shares.

We recently spoke to Nick Shenton, Fund Manager of Artemis Income, about share buybacks and the key takeaways for investors. Remember these are the views of the fund manager and not a recommendation to buy, sell or hold any investment.

This article isn’t personal advice. All investments, and any income from them, can fall as well as rise in value, so you could get back less than you invest. If you're not sure if an investment is right for you, ask for financial advice.

Remember, past performance isn’t a guide to the future. Yields are also variable and no dividend or share buyback is ever guaranteed.

Joseph Hill speaks to Nick Shenton about why now could be a good time to invest in the UK.

What do share buybacks mean for investors?

Companies are in business to make money. If they make a profit, what are their options?

"Our preferred definition of ‘profit’ is the cash left after everyone has been paid. (That ‘everyone’ includes the business itself – companies must reinvest to sustain their competitive positions.)

We focus on cash not only because companies can use it to pay dividends, but also because it’s the unvarnished truth. In contrast, accounting profits often have a tendency to come presented under a thick layer of polish.

Business leaders then have two options of how to use those cash profits.

The first is to give it back to shareholders, the owners of the business. The second is to keep it and reinvest in growing the value of the company. We like to see a mix of the two.

If a company’s management chooses to return those cash profits, a sustainable and growing dividend should be the foundational bond between the business and its owners.

Surplus profits over and above this can be returned to shareholders through one-off, ‘special’ dividend payments. Alternatively, if the company’s shares are clearly undervalued, it can use any surplus to buy back its shares.

Both are good options – but they shouldn’t come at the expense of opportunities to invest in the new business opportunities or to acquire other companies that will enhance the business’ future cash profits. Good management teams are defined by their ability to weigh these options against one another and to consistently pick the right one.”

Why might a company decide to buy back its own shares rather than further increase its dividend?

“Company leaders need to consistently perform a level-headed, logical appraisal to determine the best use of their shareholders’ cash.

Our experience suggests that asking a company’s CEO whether their shares are undervalued is akin to enquiring of your local car dealer whether it’s time for an upgrade – you shouldn’t expect an unbiased opinion. When the numbers objectively say the return on equity from buying back shares is compelling, then we are inclined to agree with the CEO (and their car dealer).

As investors seeking long-term dividend growth, we also try to keep in mind a secondary mathematical benefit of share buybacks.

Whenever the number of shares in a company falls, then its profits are divided between fewer shares. In other words, management can ‘grow’ the earnings and cash flow per share by doing no more than simply deciding to buy back some shares. All else being equal, that should mean the company’s dividend per share also rises.”

How widespread are share buybacks across the companies you hold in the Artemis Income Fund and, as the manager of an income fund, which would you prefer, share buybacks or dividends?

“This is where it gets interesting. Share buybacks are more prevalent in the UK than we’ve ever seen before (our team’s collective experience of investing in the UK market amounts to almost 90 years).

Since the start of 2021, BP, Barclays and Pearson have reduced their share counts by 17%, 14% and 11% respectively. All of these companies are held in the Artemis Income Fund – and they are all pressing ahead with further buybacks.

Why are all these buybacks happening now?

We believe we are currently witnessing a unique combination of factors:

(1) The UK stock market trades at a historically low valuation

(2) UK-listed companies have strong balance sheets

(3) UK companies are generating substantial amounts of cash”

23 of the fund’s 46 holdings (or around 60% of the portfolio by value) have bought back their shares in the past 12 months.

"So, do we prefer buybacks or dividends?

Call us greedy, but we think that today’s low valuations and high cash generation make it possible for us to have our cake and eat it. We therefore look for secure, growing dividends, supplemented by share buybacks – provided that they are well covered by cashflows.”

For long-term investors, what could share buybacks mean for returns?

“In the unlikely event that nothing changes – that the undervalued companies we invest in simply keep buying back their shares ad infinitum – then the logical outcome is that the Artemis Income Fund could end up owning the ‘golden share’ in those businesses.

In other words, our clients would collectively control the final remaining share, conferring on them full ownership of some of the UK’s leading blue-chip companies.

If that sounds unlikely, that’s because it is. The much more likely outcome, however, is still extremely attractive.

If companies are to be deterred from buying back their (undervalued) shares, then their share prices will potentially have to rise, often significantly. In that event, the capital returns for those companies’ patient shareholders would be significant.

And, while we wait for share prices to catch up with their cash profits, we can simply continue to harvest their dividends.

Last year, Tesco’s share buybacks meant that our fund increased its ownership of the company, and its future profits, by 5%, without having to spend a single penny. All the while, it paid our clients a 4% dividend yield. Every little really does help.”

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Written by
Joseph Hill
Joseph Hill
Senior Investment Analyst

Joseph is part of our Fund Research team. Having joined HL in 2017 initially on a graduate scheme, he's now integral to our analysts who select funds for our Wealth Shortlist. He also analyses the UK Growth, UK Equity Income and UK Smaller Companies fund sectors, providing expert insight for our clients.

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Article history
Published: 23rd May 2024