Share buybacks are one of several options a company has when deciding what to do with its profits and cash flows. These options are:
- Reinvest the cash back into the business for growth
- Pay the cash out as dividends
- Buy back stock
- Make an acquisition
- Leave cash in the bank account or in money market funds
Let’s briefly look at each of these options and when a company should utilise them.
Reinvesting in the business
Leave it in the bank
Buying back stock is like paying a few friends to leave the party. If the pizza cost $10, each of the 10 slices are worth (in management’s estimate) $1 per slice, at what price would it make sense to do so? Clearly, if you could get away with it, you would like to pay as many friends as possible less than $1 per slice to leave. The same is true with share buybacks. If management estimate the value per share of a company to be $1, then it makes perfect sense to buy back stock because this will increase the value per share of each dollar of earnings.
Do all management teams use this framework?
There have been some excellent acquisitions in recent years on the ASX. Altium’s acquisition of Octopart, and Aristocrat’s acquisitions of Big Fish and Plarium come immediately to mind as some of the better ones, which have returned many times the initial investment to investors.
Lead Portfolio Manager
Oracle Investment Management