What are share buy-backs and how do they benefit investors?
August is reporting season and, in addition to finding out how companies are performing in these challenging times, investors may also find themselves on the receiving end of an unexpected special dividend or an
off-market share buy-back.
What is a share buy-back?
A share buy-back is when a company offers to re-purchase some of its shares from existing shareholders. It effectively reduces the total number of a company’s shares on issue. After a buy-back a company’s profit will be spread across fewer shares, so their share prices rises, in turn boosting shareholder returns.
How do share buy-backs work?
There are two types of share buy-backs. On-market buy-backs, where a company buys its own shares on an exchange in the ordinary course of trading and off-market buy-backs, where the company makes its offer direct to shareholders.
Why do companies offer share buy-backs?
Share buy-backs can be a confusing concept for investors: Why would a company want to invest in its own shares? There are a numbers of reasons companies offer share buybacks; from cleaning up their share register, to returning excess capital to shareholders and clearing franking credits from their balance sheets.
Large corporates such as banks, major retailers, utilities and telecommunications companies, aim to return a certain percentage of their after-tax profits to shareholders, particularly if profits have exceeded expectations, as is the case for many Australian companies this reporting season. The big four Australian banks return as much as 60-65% of profits, either via special dividends or share buy-backs.
What’s in it for investors?
In the case of an on-market buy-back, an investor will make either a capital gain or a capital loss, depending on the value of the asset. A capital gain needs to be declared on your tax return and added to income, while a capital loss can be carried forward to offset other capital gains.
Off-market buy-backs, on the other hand, often have a fully franked dividend component which is especially beneficial to retirees who draw a pension from their super fund and pay little or no tax. In fact, these share buy-backs offer great value for anyone who pays less than 30% tax. Even if a share buy-back is offered at a discounted price, the franking credits that flow as result, can often deliver a net benefit to shareholders.
What’s behind the recent rise in share buy-backs?
With low interest rates fuelling investment in shares, cashed-up Australian companies are faced with the decision to either grow through merger and acquisition or return capital to shareholders. The FMD Investment Committee (IC) expects to see activity rise in both these areas over the coming quarter. Banks and miners are particularly flush with cash and preoccupied with capital management.
Last week, Commonwealth Bank of Australia (ASX: CBA) reported strong profits and announced a $6 billion share buy-back that drove its share price to a record high of $109.03, dwarfing NAB’s earlier $2.5 billion on market share buy-back. The CBA share buy-back includes a large fully franked component, providing CBA investors (especially those in pension phase) with the question of whether they should consider participating to obtain that benefit, or hold for the longer-term.
Earlier this year, FMD’s IC increased its position in larger Australian listed companies in anticipation of the COVID economic recovery. The rationale was based on a prospective rebound in profits leading to dividend increases and capital management events like CBA’s. So, while lockdown uncertainty remains, the good news is many businesses remain in strong financial shape, with the possibility of similar corporate activity ahead.
If you have any questions about your investment portfolio, please contact your FMD adviser.
General advice disclaimer: This article has been prepared by FMD Financial and is intended to be a general overview of the subject matter. The information in this article is not intended to be comprehensive and should not be relied upon as such. In preparing this article we have not taken into account the individual objectives or circumstances of any person. Legal, financial and other professional advice should be sought prior to applying the information contained on this article to particular circumstances. FMD Financial, its officers and employees will not be liable for any loss or damage sustained by any person acting in reliance on the information contained on this article. FMD Group Pty Ltd ABN 99 103 115 591 trading as FMD Financial is a Corporate Authorised Representative of FMD Advisory Services Pty Ltd AFSL 232977. The FMD advisers are Authorised Representatives of FMD Advisory Services Pty Ltd AFSL 232977. Rev Invest Pty Ltd is a Corporate Authorised Representative of FMD Advisory Services Pty Ltd AFSL 232977.