Should I sell my shares if the company is doing a share buyback?

Question

Suppose I own shares in a public company. Suppose management has started a long-term open-market share buyback program using idle cash generated purely from free cash flow. Before the open-market share buyback program, I had considered selling the shares to slightly increase my cash holdings, but seeing the share-buyback, I became hesitant to sell. My reasoning: if the company is buying back shares, it means that the company believes in itself, and believes that buying back shares at the current market price is a good deal. If it is a good deal to the company, why should I sell to it?

What is wrong with my reasoning?

Answer 1

My reasoning: if the company is buying back shares, it means that the company believes in itself, and believes that buying back shares at the current market price is a good deal

A more cynical outlook is that stock buybacks indicate that a company has cash on hand, but can't think of any good way of utilizing that money to grow the company, so they return the excess cash to the stockholders. That isn't entirely a negative. Stockholders do expect companies to provide a return on their investment. Dividends and stock buybacks are two ways for a company to do that. There is always a tension in deciding how much of a company's profits get plowed back into growing the company, and how much gets returned to the owners right now. However, it could also indicate that a company has passed its peak growth period, which might indicate an opportune time for stockholders to sell, depending on the stockholder's goals and strategies.

The darkest scenario you are overlooking is that management sometimes uses stock buybacks to prop up a sagging stock price and obscure bad financial news. That might also indicate it's a smart time to sell.

Answer 2

I tend to be quite suspicious of share buybacks. Personally I would usually rather have a special dividend. They can be beneficial under certain circumstances but I tend to be looking very carefully at the company's plan for it rather than considering it a blanket good thing.

My reasoning is:

1. Companies tend to do buybacks at the 'wrong' time, i.e. at the top of the market. If you think about it, when does a company have spare cash to be spending on a buyback? When everything is going well! A company tends not to buy back when the share price is low, usually because the price is low for a reason and the company is spending money on fixing the reason. When everything is going well, lots of investors know that it's going well and have already bought in taking the share price up. (On a side note, notice how many share buybacks have been cancelled in the last few weeks as covid hit).

2. The buyback theoretically boosts the price. I'm not convinced that it does. The shares bought back come from cash so the overall value of the company on a per-share basis stays the same. Yes, afterwards I hold a higher percentage of the company and I should benefit from a higher percentage of any capital gain in the company's value and a larger share of future profits, but for that, I'm swapping actual cash right now for potential future money.

3. Directors' remuneration and bonuses are often tied to measures like Earnings-Per-Share (EPS) which improve if there are fewer shares in circulation. If the company buys back a decent %age of shares then next year they only have to achieve the same earnings to get a better EPS number. Bonuses all round! Oh, except for me as the shareholder, I'm probably still waiting on my potential capital gain (see 2).

A couple of thoughts:

"Firms with EPS-dependent bonuses engage in more repurchases than those without, and their repurchases are not followed by positive future abnormal returns, unlike those without." https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/817978/share-repurchases-executive-pay-investment.pdf

https://www.forbes.com/sites/greatspeculations/2016/02/24/how-stock-buybacks-destroy-shareholder-value/#6ca836bc7841