“We can’t think of anything constructive to do with the company’s money, so we’re giving it back to you, dear shareholders.” Few boards would put it quite like that, but it is the logic that propels companies to buy back their own shares. Buy-backs decrease the number of shares out there, which ought to push up their price and make the remaining shareholders better off.
Well, maybe. You could also say that the company is paying some shareholders to go away, at the expense of those who remain. A pair of American academics musing about the answer to life, the universe and everything in stock markets, wondered why prices are forever jumping about. Their answer is not 42, as you might expect, but depends on the balance between companies buying back their own shares and selling more of them. Almost everything else is, according to Xavier Gabaix (Harvard) and Ralph Koijen (Chicago) in their near-incomprehensible prose, just noise.
Their “inelastic markets hypothesis” finds that “investing $1 in the stock market increases the market’s aggregate value by about $5”. They don’t mean that if you put in $1 you’ll get back $5, but that new money, as opposed to selling one share and buying another, has a ratchet effect. It turns out that most of that new money comes from the companies themselves, dwarfing the fund flows from outside investors. In the peak year of 2018, buybacks among the S&P 500 exceeded $800bn, as companies borrowed money and geared up. Conversely, when companies sell new shares, money leaves the markets.
It would be comforting to think that these insider traders were buying because their shares looked too cheap, but experience suggests that boards are hopeless at judging this, and buy-backs are a poor forward indicator. Exhibit A has to be the serial offenders at Royal Dutch Shell. We nearly all hold the shares, directly or indirectly, so the company’s inept board deserves particular scrutiny.
During 2019, Shell paid over £23 a share for buy-backs, borrowing to do so. By early 2020, as the oil price softened, it could buy back at the comparatively attractive price of around £14. Then Covid crashed the oil price. Suddenly, everything was to be sacrificed for “reinforcing business resilience and financial strength.” Buy-backs were suspended, despite the share price falling below £10. Then the board had a collective panic attack and on 30 April slashed the dividend.
Not much has improved since. The dividend policy, formerly solid for half a century, seems to change with the weather, while buy-backs are back. The shares drift along at around £14 once more. The credibility of the dividend has been sacrificed for sporadic buy-backs. A change at the top is coming, and well overdue.
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Perhaps Shell’s new man could take a lesson in how to do buy-backs from Simon Wolfson, the brutally honest shopkeeper who runs Next. He believes in buy-backs, but he sets out the rules (and prices) at which he reckons the company’s money is better invested in its shares than stores (or on-line).
This rational use of the company’s capital has been almost universally ignored by others, where the standard approach is to set aside a sum and keep buying until it’s all gone. Unfortunately, it’s not so hard to see why. Dividends are of little interest to most executives, whose prize is to cash in their share options at a high price and become rich. If some banker can convince them that buy-backs raise share prices, who can blame them?
Time to takeaway this index
It seems that Just Eat Takeaway is not a British company after all. The boffins at FTSE Russell have been labouring away, fortified only by the occasional late-night tikka masala, and now conclude that last year’s merger of Just Eat of the UK and Takeaway of The Netherlands turns the whole thing Dutch, so it must leave the FTSE100 index. The departure follows that of BHP, as the Aussie miner scrapped the pretence that it was as British as it is Australian, and ought to prompt an examination of what this index actually does.
As a measure of the state of London’s equity market, it’s pretty hopeless. The constituents are selected mechanically by market value, which means domination by banks, tobacco, oils and miners, all of which have been mediocre, poor or very poor performers for years. The FTSE250 index, which applies the same rigid criteria for the next 250 largest stocks but is a better indicator of the health of UK plc, has far outperformed its big brother.
No index can capture everything without becoming meaningless, and the 100 was an improvement on London’s first shot, which picked 30 “leading industrial”stocks. It was calculated by multipying all the prices together and dividing by 30, thus producing the risk of going to zero if one stock went bust. Today’s FTSE100 is a convenient shorthand for one day’s market movement. As a long-term indicator, its time is surely up.
Such a relief for Lloyds
Banks usually only go into the property business when the borrower fails, so it is imaginative of Lloyds to announce plans to plunge into residential buy-to-let, even while the fiscal sun is shining. Like all its competitors, Lloyds has more capital than it knows what to do with, and it is not allowed to give the excess to the long-suffering shareholders.
So rather than crank up the mortgage war still further, it is going up the food chain, to buy completed homes from the builders before anyone else, and renting them out. At present, the builders have no trouble finding buyers (often with Lloyds’ money), and it is not obvious to outsiders how banking expertise translates into fixing the plumbing or mending a broken window, but still. It was a banker, Nick Sibley, who once mused that a bank with too much capital would find a way to squander it, and it was just a question of which wall it would choose. Different this time, of course.