Companies on the S&P 500 index spent $3.9-trillion buying back their own shares in the five years to 2022. This surpasses the $2.5-trillion they paid out in dividends over the same period. Buybacks divide opinion but one thing is clear: corporate buying has provided an incremental source of demand for US shares.
Our new research confirms that buybacks continued to be more popular in the US than in other major markets in 2022. But that gap narrowed – with their use becoming more widespread in the UK, Europe and Japan. Buyback activity will always fluctuate over time, and one year doesn’t make a trend. But as a tailwind for equity demand and a mechanical boost for earnings per share numbers, their increased popularity outside the US is worth keeping an eye on.
Why buybacks are a divisive subject
Share buybacks divide opinion. On the one hand, they are a way for company management to return excess cash to shareholders in a way that is less binding than a dividend increase. And they can be more tax efficient for investors as capital gains are often taxed at a lower rate than income. On the other hand, they are open to criticism about being open to manipulation by management. The same earnings divided by a smaller number of shares leads to an increase in earnings “per share”. If executive remuneration is naively linked to earnings per share growth this could be enriching management at the possible expense of shareholders.
Some also argue that they are a way for management to prop up an ailing share price, again potentially to boost their compensation. But the counterview is that if management believes their shares to be undervalued then this would be the best time to buy back their shares. An increase in buybacks may also signal an absence of profitable investment opportunities for the company concerned. So, rather than a positive, they could be interpreted as a negative. One indication of the strength of feeling about buybacks is that US policymakers have recently introduced a “buyback tax”, forcing companies to pay tax amounting to 1% of the value of any buybacks. This came into effect on 1 January 2023.
US still leads buybacks, but UK and other markets closed the gap in 2022
Based on our calculations, 45% of large US companies bought back at least 1% of their shares during 2022 (net of any shares that were issued). This is broadly in line with the average of the three years before Covid (buyback activity dropped dramatically in 2020, distorting any calculations encompassing this period).
More unusually, UK companies almost matched the US on this basis last year (Figure 1). The proportion of UK companies buying back at least 1% of their shares soared to a record high in 2022. There has also been a rise in buyback activity among Japanese, French and German companies. Activity remains limited in emerging markets. In Japan’s case, many companies are valued at less than the book value of their shares and are hoarding cash. With regulators keen to see improvements in firms’ capital efficiency, buybacks can be considered one effective use of that cash, especially if shares can be bought back at a cheap valuation.
Buybacks are less common among smaller companies
Intuitively, smaller companies are less likely to engage in buyback activity and more likely to issue new shares than larger companies. Smaller firms are typically growing quicker and so potentially need the extra capital. This may also explain why emerging market companies have been less keen on buybacks. We can see this effect by comparing the proportion of large-cap companies buying back 1% of their shares (net of any issuance) with the proportion of the overall market doing so (Figure 2). And the same analysis is based on the proportion increasing their share count by 1%. For example, there are 627 companies in the MSCI USA index but 2 470 companies in the MSCI USA Investible Market Index. The difference between these two indices is the inclusion of 1 843 small and mid-cap companies, which make up 75% of the total. In all major markets, the number of small and mid-cap companies far outweighs the number of large companies.
Continuing with the US as an example, 45% of large US companies bought back at least 1% of their shares in 2022 compared with 33% of the broader corporate universe. In contrast, 20% of large US companies increased their share count by at least 1% compared with 30% of the broader corporate universe. This difference in behaviour between large companies and the broader market holds across other markets.
Buybacks and “de-equitisation”
There’s been much commentary around the shrinking pool of investable public equities in recent years. One way this happens is when more companies leave the market through de-listings (down to mergers and acquisitions) than join through new listings/initial public offerings (IPOs).
But buybacks also remove equity from the public markets. By carrying out a similar calculation to that used above but applying it to the stock market rather than individual companies, we can get a sense of the scale of this “de-equitisation” trend. Unlike the previous analysis which focussed on net buybacks alone, this captures the combined effect of net buybacks and new entrants/delistings. We refer to this as “net equity supply”.
Our analysis is based on the broad stock market of large, mid and small companies in each country to remove any distortions from companies being promoted/demoted from one size segment to another. For the same reason, we focus on individual countries rather than regions. The aim here is to capture only genuine changes in equity supply. In the 12 months to July 2023, net equity supply was negative in the US, UK, Japan, France and Germany (Figure 3). However, what is most striking is that the pace of de-equitisation has recently been greater in non-US markets than in the US. Mergers and acquisitions explain some of this. For example, UK companies have traded at a discount to US companies, making them attractive acquisition targets by both US companies and private equity.
Delistings have also picked up considerably in Japan, with figures for last year almost triple what they were a decade earlier.
With non-US companies continuing to be valued at steep discounts to their US peers, their appeal as takeover targets is unlikely to wane.
While much focus has been on the declining number of listed companies, we shouldn’t forget the contribution of share buybacks to the trend of de-equitisation. Use of share buybacks picked up significantly in 2022 and it will be interesting to see if this continues in the years ahead. With global interest rates expected to be higher for longer and a continuing weak growth outlook, firms have a lot to consider.
They’ll be working out how to use any excess cash, the extent to which their equity prices look cheap, and whether the flexibility of buybacks is more attractive than dividends in an uncertain environment.
Corporate buying, whether through buybacks or mergers and acquisitions, has the potential to support share prices. For investors, the increased popularity of buybacks outside of the US will be a trend to watch. And, so long as non-US companies continue to trade at large valuation discounts to their US peers, they are likely to feature prominently on lists of potential takeover targets.
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