Why increasing share buybacks are a positive signal for UK equities

More and more company management teams are announcing share buybacks. And they are not confined to the FTSE 100 juggernauts. Increasingly, smaller companies too are deploying cash to buy up their own shares.

Last year, 30 companies listed on the FTSE All-Share saw their total number of shares fall by 5per cent or more and this was to a large extent due to buybacks¹. In three years, 27 companies have purchased 10per cent or more of their own shares. In 2023, roughly one in eight smaller companies listed in the UK bought back their own shares.

In our own small-cap portfolio, we saw 11 companies engage in share buybacks last year. In 30 years as a small-cap investor, I have never seen this level of buybacks among the UK’s smaller companies.

The key question is, of course, whether this is good news for investors. Some insist they would rather see profits returned as dividends. However, we take the view that what matters to our investors is the total return – and buybacks can play a useful role in bolstering capital growth.

This share price appreciation can also be more tax-efficient for investors, because capital growth is typically taxed at a lower rate than income. If an investor needs income, they can always sell some shares.

There is another reason for investors to be positive about buybacks. Analysis reveals that since 2016 the 20per cent of FTSE SmallCap companies spending the most on buybacks as a proportion of their market capitalisation have delivered in the region of double the return for the overall index².

Need for vigilance

Critics often level the claim that management teams can use buybacks as a tool to inflate their company’s earnings per share (EPS) – and thus their own remuneration, which is often linked to EPS. This underlines the need for vigilance and we keep a sharp eye out for any unsatisfactory practices.

Another potential issue is companies buying back shares when the price is high. While this benefits sellers, long-term investors may not see it as the most effective way for a company to deploy excess cash.

However, with the UK market unloved and good quality companies languishing on the valuations we are currently seeing, we are more than comfortable with businesses buying back shares.

Vote of confidence

The UK is firmly out of favour with global investors, with price/earnings multiples close to the lows of 2008/9 and at similar levels to when the world was grappling with COVID-19 in 2020.

Valuations look particularly cheap among smaller companies, despite historical data that shows strong outperformance by these smaller companies versus their larger counterparts. The Deutsche Numis Indices 2024 Annual Review shows that between 1955 and 2023, the DNSC 1000 index (excluding investment trusts), which represents the bottom 2per cent of the main UK market, achieved an annualised return of 15.6per cent. The Deutsche Numis Large Cap Index (excluding investment trusts) delivered annualised growth of 11per cent over the same period.

The view among global asset allocators seems to be that the UK and its companies are floundering and that, buffeted by elevated inflation, higher interest rates and economic uncertainty, smaller companies in particular are struggling.

However, this is at odds with what we are hearing first hand in our meetings with the management teams of the majority of companies we hold in the fund and those we are talking to with a view to possible future investment. In many cases, they are reporting robust trading and continuing growth.

We take the view that nobody understands these companies better than the people managing them on a day-to-day basis. If they believe their shares look undervalued and are buying them back on behalf of the company then we view this as a strong vote of confidence.

Share buybacks also serve to remind us that not all smaller companies have high levels of debt on the balance sheet. The reality is many are producing excess cash, a fact which we see as further reinforcing the investment case for UK smaller companies.

We see a strong long-term opportunity in UK equities and particularly in smaller companies. The increasing number of share buybacks underlines the value that those who understand these companies the best – the management teams running them – see in their businesses. In our view this is a very positive signal for investors.

Mark Niznik, co-manager of the Artemis UK Smaller Companies Fund

¹  This list does not include investment trusts, some of which have discount control policies which force them to buy back shares when discounts widen. Source, Bloomberg

² Sources, Liberum and Datastream

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