How do share buybacks affect share prices?
Why investors benefit from share buybacks
Expert for banks and stock exchanges As of December 11, 2018
Hendrik Buhrs is an editor in the bank and insurance team. Before joining Finanztip, he reported on economic and consumer issues for the radio programs of the Hessian and later of the West German Broadcasting Corporation. Hendrik studied economics in Münster and Exeter. He gained his first professional experience at Radio Q and on Recklinghausen local radio. He likes to invest the money he has saved in travel.
- With a share buyback, a company buys back shares from shareholders.
- The company can acquire its own shares directly on the stock exchange. Or it makes a public offer to its shareholders to buy back the shares.
- The capital market generally rates a share buyback as positive: the share price can rise for a short time.
- Even with the public buyback offer, there is usually a surcharge on the stock exchange price for the shareholders.
- The company can only buy its own shares if the general meeting has authorized the management board to do so in advance.
- A share buyback is often associated with markups. Use the price jump to review your long-term investment strategy.
- Even if the share did well: When investing in individual shares, your investment success depends on the economic success of only one company. Think carefully about whether you want to expose yourself to this risk.
- On the other hand, a strategy in which you invest widely in stocks from many industries and countries with inexpensive index funds (ETFs) is less risky.
- If you use the share buyback to switch to ETFs, you should also take care of a cheap, good securities account. We recommend Onvista Bank and Flatex.
Whether Munich RE, Allianz, Siemens, Adidas or Linde: All of these Dax companies have already had shareholders Shares bought back. Share buybacks are said to have brought German companies more than four billion euros in 2017 alone. There can be several reasons behind the measure. Often benefit shareholders.
What do share buybacks bring for shareholders?
If a company announces a share buyback, it is almost always one positive message for shareholders: The company signals that it considers its own shares to be a good investment. Other market participants must assume that the board of directors knows more about the company's prospects than they do and that there are good reasons for optimism. So you also access: The Share price rises.
Even if the company makes a public buyback offer to its shareholders, the shareholders benefit: Such an offer is only attractive if the shareholders receive more money than if they were sold on the stock exchange. So the company must first offer a price that above the current market price lies. In this way, too, the value of the shares increases with the announcement of the share buyback.
Shareholders who keep their shares also benefit from a higher share price. Because there are fewer stocks in circulation, there is usually one too higher dividend. You can find out why this is so in detail below.
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How exactly do share buybacks work?
Before the company can buy its own shares, the company's general meeting (AGM) must allow the management board to do so: The AGM passes a resolution in which it “authorizes” the management board to do so. However, the authorization is limited: at most 10 percent of its share capital can acquire the company with such a resolution. This is valid for up to five years and allows the company to complete the buyback program within this time. The consent can be linked to a specific purpose and amount.
Almost all companies listed in Germany have one Authorization "in stock" give at the annual general meeting. The authorization neither forces the company to develop specific plans for a buyback program, nor to actually implement one. A corporation is planning a buyback program, but has to make it public when it begins.
The Stock Corporation Act states the additional conditions under which companies may still buy back their own shares.
Buyback on the stock exchange or offer to shareholders
There are several ways a company can buy back its own shares - either on the stock exchange or directly from shareholders. If there are too few purchase options or if the group shies away from the price effect on the stock exchange (after all, the company has to buy more and more blocks of shares gradually), it can submit a buyback offer to its shareholders. As soon as the company announces its offer, the price it will pay for the shares is fixed.
Important to consider: If you sell your shares as a shareholder as part of a buyback, you naturally lose your rights as a shareholder, i.e. voting rights and the prospect of a dividend payment.
According to section 71b of the company law, however, the following applies: The company is not entitled to any rights from its own shares. Future profits and dividends are therefore distributed over fewer shares, and the price-earnings ratio, which is important for the valuation of the share, also falls. That is why there is occasional talk of a share buyback serving to "maintain prices".
Why do companies buy back their own shares?
The reasons for buying back your own shares are complex. As a rule, corporations buy back shares when they have no better use for their financial resources, i.e. they do not need any money for investments and do not see any attractive investment opportunities. In any case, the share buybacks reduce the number of freely available shares, the so-called free float.
In addition to the Price increase There are other reasons why companies buy back shares:
Validation - Stock corporations can thus protect themselves against a takeover of the competition, for example. Because it becomes more difficult for other companies to buy into the group - since there are fewer shares on the free market and the existing securities have a higher price.
Means of payment - However, if a stock corporation wants to take over another group, it can use its own shares as a means of payment. The own shares then serve as exchange or transaction currency to buy up the other group.
Increase in motivation - Companies can also issue the shares they have bought to their employees. The employee shares are then a kind of bonus to increase motivation.
Reduction - If the corporation cancels the shares it has bought and thus permanently reduces their number, it can distribute the profits it wants to distribute to the shareholders among fewer shares. The repurchases can increase the dividend for shareholders.
Concentration - If the group withdraws part of its own shares, this usually also reduces the number of shareholders. In this way, the company can change its shareholder structure - the number of those who can have a say at the general meeting also decreases.
What are the criticisms of the share buybacks?
Share buybacks are controversial among some experts, especially with regard to the long-term perspective of a company. The following arguments are often used:
No economic added value - Short-term price increases only serve to keep shareholders happy. Actually, share buybacks speak for a certain lack of ideas on the part of the corporate management. The stock corporation later lacks money that it could invest in new projects, machines or research.
Harmful to growth - Failure to invest in the long term can have a negative impact on the company's growth. For example, because the competition is evolving and the stock corporation eventually depends. In addition, funds that flow into buyback programs may lack the company as a financial cushion in times of crisis.
Bonus for the board of directors - Sometimes the remuneration of board members in the company is variable and depends, for example, on the company's success on the stock exchange. Some board members can therefore collect more money through rising prices after a share buyback.
Investment bubble - Share buybacks can also be financed with borrowed capital. That is, the company takes out loans to buy shares from shareholders. This will only work as long as the company continues to generate profit. If it does not do this, it will no longer be able to service loan interest in the medium term and will get into financial difficulties.
Can you benefit as an investor?
Some investors are specifically looking for public companies that regularly purchase their own securities. There are also special funds that pool shares in companies that have the prospect of a buyback. Such strategic funds are only for professional investors who already have a well-positioned portfolio and want to optimize it. You can read more on the subject in our Smart Beta ETFs guide.
If, on the other hand, you are approaching the stock market for the first time and have the goal of building up assets consistently over the long term, you should rather buy so-called stock index funds (ETFs), which track a global stock index. For example, Finanztip recommends ETFs that track the MSCI World share index. The risk of loss is spread across a good 1,600 companies.
More on this in the index funds / ETFs guide
- With inexpensive ETFs, you can easily build wealth.
Our ETF recommendations forMSCI World-ETFs: iShares (ISIN: IE00B4L5Y983), Xtrackers (ISIN: IE00BJ0KDQ92) and Source (ISIN: IE00B60SX394); ForMSCI-All-Countries-World-ETFs: SPDR (ISIN: IE00B44Z5B48) and iShares (ISIN: IE00B6R52259)
To the advisor
Sara Zinnecker was editor for investment topics until June 2020. Sara had previously written about investments and retirement provision for the Handelsblatt. She completed her traineeship at the Georg von Holtzbrinck School for Business Journalists.
Dr. Manuel Kayl
Manuel Kayl was responsible for investment topics at Finanztip. The doctor of physics worked as an investment strategist and risk manager at the Dutch insurance company a.s.r. after doing research at the Geneva research center Cern as well as at Nikhef and the University of Amsterdam. He left Finanztip on August 31, 2016.
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