Are share buybacks good, bad or completely overvalued?

The heads of listed companies like to praise their share buybacks in the highest tones - most recently at Roche. However, investors should closely monitor what is going on.

"Destruction" is an unpleasant word. But this is exactly what happens with about 53 million bearer shares of the Basel based pharmaceutical company Roche. The company does not only buy this shares from the competitor Novartis, as was surprisingly announced last week, the shares, at a value of about CHF 19 billion, are also withdrawn from circulation. As a result, there will be fewer Roche shares than before listed.

A signal effect is quite desirable

There are a number of corporate policy reasons for the purchase of the Roche share package, which Novartis had taken over from investor Martin Ebner in 2001. The unbundling of both companies is one consequence, the increase in the majority share of the Roche Hoffmann-Oeri family heirs to up to 75 percent is another. Investors are also interested in how this affects their investments.

Roche is carrying out nothing more than a share buyback. Such a step is not uncommon - it is special at best that the repurchased shares at Roche come only from one shareholder. As can be seen at Roche, an important motive for share buybacks is that the reduction in the shareholding makes a single share more valuable - this can be seen, for example, in the key figure "earnings per share" or EPS. This should benefit the share price.

Share buybacks are an instrument of management

This form of course maintenance is also called "signalling". A signal effect should be generated especially if the price of a share is considered undervalued. Indirectly, the repurchasing management also sends a signal that there should be more in a stock.

Research also suggests that excess returns are frequented for stocks that were downgraded particularly sharply by analysts before the announcement of the share buyback. The effect seems to be even stronger when it comes to smaller companies with relatively low analyst coverage.

However, the fact is that the top guys of listed companies often praise share buybacks in big words. Roche President Christoph Franz also tried last week to make the Novartis deal appear in the best possible light. Companies have some advantages through this process. Sometimes these are tax-related, but a consolidation of share capital can also better protect against takeovers. If the shares are not destroyed as in the current case at Roche, the company can, for example, use them for employee bonuses.

But there is an important downside. Share buybacks are not very original. A management can give the impression that they do not know better where to put the money. Because the funds for the share buyback could also be used for dividend increases or special dividends. Money that goes into share buybacks does not flow into potentially forward-looking investments such as research, development or acquisitions. A share buyback can be interpreted as reaching the limits of growth opportunities.

Same intention, different results

This is an important point for investors. Credit Suisse, for example, obviously does not convince the market with share buybacks. The stock market price shows that other problems weigh more heavily in this year's SMI taillight. Swiss Re also likes to buy back its own shares, whereby it also distributes a sumptuous dividend. However, the price of this reinsurer share has not really come off the mark for years. With Swiss Life, on the other hand, in addition to the increased dividend, the prospect of further share buybacks should also give a positive picture. Swiss Life is also the top performer among Swiss insurers this year thanks to the business model, which is currently considered functional.

However, the example of Swiss Life shows that share buybacks play an important role in market expectations. These can contribute a lot to the price development. If a company has a full cash register, this also arouses desires in the shareholders' office. According to funds, stock strategists or analysts speculate a lot and often about possible share buybacks.

The approval rate for share buybacks at general meetings shows that this instrument is generally popular with investors. Shareholders also love dividends. However, these have to be taxed in places like Switzerland, but any price gains - with or without share buyback - do not. Otherwise, however, nothing helps: Depending on the company, management and current market value of a company, a share buyback can trigger different things.

It depends on the motive

Management decisions such as share buybacks are the subject of scientific research. However, one fact is that there is controversial debate about the motives, benefits and effects of share buybacks. It is important for investors to look at the motives of share buybacks: If shares are destroyed, this is ultimately better for the price than if the repurchased shares flow into remuneration systems.

If management pays a premium, this makes a stock attractive. If it pays too high a premium, this can be interpreted as an act of despair. However, it is also interesting to what extent large shareholders offer shares when buying back shares: If they do not do so, this is an indication of a rather high level of trust in a company. In the end, however, a share buyback is only a point of view that can speak for a stock.

If share buybacks or speculation about them accumulates, this is also a sign of a troubled market. In the USA, companies are likely to buy back more own shares than ever after the third quarterly season, which is currently running. If the market really gets restless, then even the best price maintenance via share buyback no longer helps much.

Sustainable course maintenance only exists if management acts credibly.