Two weeks ago, the Straits Times published an article about the trend of share buy backs in the Singapore stock market. To summarize, listed companies in Singapore bought back more shares in June than they had in each of the previous eight months. Total buybacks in June amounted to $51.5 million. However, this was still some way short of the total amount of stock bought back a year ago. Back then, $218 million was used for share repurchases. The first six months of this year also represented a 63% decrease in total share repurchases compared to the same period in…
Two weeks ago, the Straits Times published an article about the trend of share buy backs in the Singapore stock market.
To summarize, listed companies in Singapore bought back more shares in June than they had in each of the previous eight months. Total buybacks in June amounted to $51.5 million. However, this was still some way short of the total amount of stock bought back a year ago. Back then, $218 million was used for share repurchases.
The first six months of this year also represented a 63% decrease in total share repurchases compared to the same period in 2016.
Before we analyze what this could mean for shareholders, we can take a look at some of the reasons companies choose to buy back shares.
What are share buybacks
Share buybacks, or repurchases, happen when a company buys back its shares on the market place and these shares are then converted into treasury shares.
By buying back shares, companies reduce the total number of shares available in the stock market, hence concentrating the percentage of the company that an existing shareholder owns.
This naturally means, that if all else remains the same, the intrinsic value of each share will increase. But do take note that buying back shares comes at a cost. When a company uses its cash to buy back its shares in the open market, its cash reserve will drop, meaning the intrinsic value of the company is now reduced, all else being equal. So, the company must make sure it is buying shares of itself at prices that represent good value.
The second reason to buy back shares is because the company realizes that its shares are undervalued on the stock market. By seizing the opportunity to buy its own undervalued shares, a company can increase shareholder value by reissuing shares at a later date when the market recognises the value of its shares.
Having said that, some companies have put in place share repurchase programs that can be dangerous and may decrease shareholder value. This is because a company that buys back its shares at a price higher than the fair valuation of the shares is not using its cash efficiently. This can happen when management receives poor advice from banks or have no experience managing the company’s capital.
What does this mean for the Singapore stock market
Share buybacks have not been high in the Singapore scene lately. One of the reasons is that the Straits Times Index (SGX: ^STI) has climbed from around 2,900 points one year ago to nearly 3,300 points today, meaning that many companies’ shares in the Singapore stock market have likely gone up in price. Company’s management may not think that share repurchases can add value to shareholders at current prices.
There could also be other reasons, such as a company realising its capital is required for day to day operations. Companies may also find other investment opportunities that make more sense than share repurchases. Many companies in Singapore also choose to give out dividends instead of using the capital for share buybacks.
The Foolish bottom line
Share buybacks can be a useful tool for companies to create value for shareholders by decreasing the total number of shares outstanding.
But it is also important that companies know when to use share repurchase programs. I believe billionaire investor Warren Buffett summarizes this nicely in his 2012 annual letter to shareholders:
“Charlie [referring Charlie] and I favour repurchases when two conditions are met: First, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s instrinsic business value, conservatively calculated.”
Any company’s management should heed the wise words of the Oracle of Omaha and only carry out share repurchases when it makes sense to the company and its shareholders.
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