Stock-market investors get excited when a company announces that it is buying back its own shares in the open market. Here are two recent examples of major companies engaging in this practice. “Semirara Mining [SCC] launches P2-B share buyback”
on December 7, 2017, and previously “AGI [Alliance Global Group, Inc.] sets P5B stock buyback” in September 2017.
A publically listed company announcing a share buyback program is like getting a beautifully wrapped Christmas present from your Tita Malou. The problem is that Tita is getting on in years and becoming forgetful. You are hoping that she is gifting you with the PIN number to her fabulously large bank account. However, the box may contain a plastic bag of dirty clothes that was supposed to go to the labandera.
Why would a company use its cash to buy back its own shares? Isn’t a corporation supposed to share the profits with shareholders in the form of cash dividends?
Warren Buffett’s holding company—Berkshire Hathaway—does not pay cash dividends but uses the excess funds to buy its shares. Buffett says this method of returning value to the owners is “cleaner” in that there are no tax consequences until the shares are sold. But how do shareholders benefit? If the company buys back 1.5 percent of the outstanding shares, that reduces the amount of shares in circulation and theoretically increases the value of those shares by 1.5 percent.
A corporation may decide that its shares are “undervalued” and buys the shares at what it considers a “cheap” price with the intention of selling those shares in the future at a higher price. That is a business decision with the company making an investment in itself as it might in buying another company. It is a hybrid of a merger and acquisition.
But let’s be realistic. The investing public figures the stock price is going up and wants to make a quick buck. Financial analysts look at the transaction to see if the company is diverting funds that could be used to expand the business and make a longer-term profit. The bean counters are worried that the company is borrowing money to buy the shares.
The market capitalization—the value of all shares—of the 30 issues on the Dow Jones Industrial Average index increased in 2016 by almost the same amount as the amount of money spent by those companies on share buybacks. In other words, the share buybacks increased the value of the shares, not public buying. At least, that is what it looks like on paper.
At the announcement of the buy-back program, AGI was trading at about P15, and SCC was around P38. The current prices are approximately P14.50 and P31, respectively. But who is to say what the prices might be if the company had not bought its own shares?
The best Christmas presents do not always come in the package with the big fancy ribbon. The best profit opportunities are not always found with the big headlines. Company stock buybacks can have a much better function.
Quietly and without either hype or price increase, a company may be buying its shares for another long-term purpose.
A corporation looking for a strategic partnership involving either a share swap between companies or a joint- venture buy-in for shares may slowly acquire additional shares from the open market. This should be done at a price below what the fair value of the company happens to be. If and when an outside merger is announced, the company can use its cheaply acquired buy-back shares to fund the new arrangement and make a substantial profit both short and long term. That is where you want to be.
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E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.