insight

Buybacks may be a better option

THE government will introduce a 2.0 per cent tax in the year of assessment 2025 on dividend income exceeding RM100,000 received by individual shareholders.

This may prompt some companies to consider share buybacks as an alternative to distributing dividends. Or consider a combination of both.

Share buybacks have gained significant popularity in recent years, often favoured over dividends by many companies for their flexibility, and ability to enhance shareholder value in strategic ways.

There are advantages of share buybacks over dividends, including enhanced capital efficiency, share price support, signalling confidence to the market, flexibility in timing and scale.

 

Enhanced Capital Efficiency

One of the most significant advantages of share buybacks is their ability to enhance capital efficiency.

In a buyback, the company repurchases its own shares from the market, reducing the number of outstanding shares. This reduction leads to an increase in earnings per share (EPS) since the company's total earnings are spread over fewer shares.

A higher EPS generally reflects positively on the company's financial health, attracting more investors and potentially boosting the share price.

Dividends, by contrast, are a one-time cash payout that does not directly impact EPS or capital efficiency.

The payment reduces the company's available capital without necessarily improving key financial metrics. While dividends do provide immediate income to shareholders, they don't offer the compounding benefits to EPS and market perception that buybacks do.

 

Share Price Support

Share buybacks can provide support to a company's share price, especially during periods of market volatility or when a company believes its share is undervalued.

By reducing the supply of outstanding shares, buybacks create a demand-driven boost in share price.

The perception of scarcity increases as fewer shares are available for trading, thus exerting upward pressure on the share price.

This can be particularly beneficial during times of economic uncertainty or when a company's share is underperforming. The buyback signals that the company believes its share is undervalued, and it is willing to invest its capital to correct that.

Dividends, while providing regular income to shareholders, do not directly impact the share price in this way.

Once the dividend is paid, the share price typically adjusts downward by the amount of the dividend, making it a neutral event from a share price perspective.

 

Flexibility in Timing and Scale

Another advantage of share buybacks over dividends is the flexibility they offer companies in terms of timing and scale.

Dividends are generally expected to be consistent and, once initiated, shareholders often expect them to continue and even increase over time. This creates a long-term obligation for companies that may constrain their financial flexibility.

Reducing or eliminating dividends can send a negative signal to the market, often resulting in a sharp decline in the stock price.

In contrast, share buybacks provide companies with much more flexibility. A company can choose to initiate, pause, or discontinue buybacks without the same level of market scrutiny. This allows companies to take advantage of opportunistic moments, such as repurchasing shares when share prices are low.

Buybacks do not create the same long-term obligations or expectations, giving management more room to adapt to changing market conditions and company priorities.

 

Signalling Confidence in Future Prospects

  Share buybacks can serve as a strong signal that the company's management believes in the future growth and profitability of the business.

When a company chooses to buy back its shares, it is essentially signalling to the market that it believes the share is undervalued and that reinvesting in itself is the best use of its capital.

This can enhance investor confidence and drive positive sentiment about the company's prospects.

While dividends also signal that a company is generating sufficient cash flow, they may not carry the same sense of confidence in future share price appreciation.

Buybacks suggest that management believes the company's share will perform better in the long term, making it a compelling option for long-term investors.

 

Mitigating Shareholder Dilution

Buybacks can help mitigate the dilution of shareholder value caused by share-based compensation programs. Many companies, issue significant amounts of share grants and employee share option schemes (ESOS) to executives and employees.

These share grants dilute the ownership of existing shareholders by increasing the number of outstanding shares.

By repurchasing shares, companies can offset the dilution created by these share-based compensation programs, preserving the ownership percentage of existing shareholders.

Dividends do not offer this benefit. In fact, paying dividends on an increased number of shares would require the company to distribute more cash, which could further strain resources.

 

Higher Returns for Long-Term Shareholders

For long-term shareholders, buybacks can deliver higher total returns compared to dividends.

When a company buys back its shares, shareholders who retain their shares benefit from the increase in EPS and the potential for long-term stock price appreciation.

Long-term investors may prefer buybacks because they align more closely with wealth- building strategies, allowing them to benefit from market appreciation rather than relying on periodic income from dividends.

*The writer is a former chief executive officer of Minority Shareholders Watch Group and has over two decades of experience in the Malaysian capital market.

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